“Courts have consistently found that criminal proceeding admissions of a fraudulent scheme to defraud investors made in guilty pleas and plea allocutions are admissible as evidence of ‘actual intent’ to defraud creditors.”
How later courts described this case
- “Courts have consistently found that criminal proceeding admissions of a fraudulent scheme to defraud investors made in guilty pleas and plea allocutions are admissible as evidence of ‘actual intent’ to defraud creditors.”
- “The malicious intent sufficient to support a cause of action is set forth in the disjunctive — a plaintiff may avoid the transfer where it was made with intent “to hinder, delay, or defraud.” ”
- "Guilty pleas and plea allocutions in criminal cases are admissible evidence in subsequent civil proceedings. See Fed. R. Evid. 803(22) and 807."
Written by the judges who cited it.
The opinion
DECISIONS ON CROSS-MOTIONS FOR SUMMARY JUDGMENT
AD LAI S. HARDIN, JR., Bankruptcy Judge.
Table of Contents
Page
Jurisdiction.822
Overview of the Facts.822
Prior Motions to Dismiss.824
Discussion.824
I. Standards for summary judgment.824
II. Section 548(a) issues and conclusions.825
A. The statute and case law.825
B. The evidence: criminal pleas/allocutions and the Lenhart Report.828
1. What the evidence shows.828
(a) Guilty pleas and allocutions.828
(b) The Lenhart Report.831
2. Admissibility.834
(a) Guilty pleas and allocutions.834
(b) The Lenhart Report.835
C. No triable issues of fact.842
D. Ultimate findings and conclusions.842
1. Actual fraud under Section 548(a)(1)(A) .842
2. Constructive fraud under Section 548(a)(1)(B).843
III. Section 548(c) issues and conclusions.843
A. The statute and case law.843
B. Background: good faith defenses accepted by plaintiffs .853
1. Proceedings not settled.853
John Barr III IRA and John Barr III (Adv.Proc. No. 07-08244) Myrna Bennett (Adv.Proc. No. 06-08420) Madison Capital Advisors Ltd. (Adv.Proc. No. 06-08403).853
2. Proceedings settled.853
C. Good faith defenses sustained.854
1. DB Structured Products, Inc. (Adv.Proc. No. 06-08494).854
*821
2. High Sierra Investments (Adv.Proc. No. 07-08243).856
3. Michael Mann (Adv.Proc. No. 06-08419).858
D. Issues of fact requiring a trial.860
1. William Strang (Adv.Proc. No. 06-08387) Randall M. and Sheryl B. Rothstein (Adv.Proc. No. 06-08389) Alan Osofsky (Adv.Proc. No. 06-08398) DW Resources DBP and Marc Daniels (Adv.Proc. No. 06-08415) Marc Fleisher IRA and Marc Fleisher (Adv.Proc. No. 06-08423) Kevin Bass (Adv. Proc. No. 06-08431) Michael Davidson (Adv.Proc. No. 06-08435) Neil D. Cohen (Adv.Proc. No. 07-08245) Edward and Virginia Sorkin (Adv.Proc. No. 07-08246) .860
2. Mary Jane Pidgeon Sledge (Adv.Proc. No. 06-08339) .860
3. Sterling Stamos Funds (Adv.Proc. No. 06-08493).861
4. Highgate Partners LP (Adv.Proc. No. 06-8412).863
E. Summary judgment granted for plaintiffs.865
1. Background: the Altegris due diligence .865
2. Background: the Westervelt complaint.867
3. Investigation by CSG and Centennial.869
4. Imputation of CSG’s knowledge to its clients .872
5. Facts specific to the CSG or Centennial clients.874
(a) Redwood Growth Partners, L.P. (Adv.Proc. No. 06-08318) Heritage Hedged Equity Fund LP (Adv.Proc. No. 06-08333).874
(b) Christian Brothers High School Endowment (Adv.Proc. No. 06-08320).874
(c) D. Canale Beverages, Inc. (Adv.Proc. No. 06-08321) John D. Canale III (Adv.Proc. No. 06-08336).875
(d) Marvin E. Bruce Living Trust (Adv.Proc. No. 06-08368).876
(e) Mary P. Smythe Residuary Trust (Adv.Proc. No. 06-08338).877
(f) KFI Capital Partners LLC (Adv.Proc. No. 06-08337) YK Investment Partnership II (Adv.Proc. No. 06-08341) Helen Yulman Revocable Trust (Adv.Proc. No. 06-08332) Mayer and Morris Kaplan Foundation (Adv. Proc. No. 06-08340) .878
(g) Fred Montesi IRA and Fred Montesi (Adv.Proc. No. 06-08329).879
6. H & B Hedge Fund II LLC (Adv.Proc. No. 06-08422).879
7. Freestone Low Volatility Partners LP (Adv.Proc. No. 06-08373).880
8. Peter Haje IRA and Peter Haje (Adv.Proc. No. 06-08430).881
IV. Fictitious profits calculation on 2003 fund exchanges.884
Orders.885
Before the Court are motions, and in most cases cross-motions, for summary judgment in thirty-three adversary proceedings brought by plaintiffs-debtors Bayou Accredited Fund, LLC, Bayou No Leverage Fund, LLC and Bayou Super-fund, LLC (collectively “plaintiffs,” or the “Bayou hedge fund[s],” or simply “Bayou”) against defendants-investors in the Bayou hedge funds who successfully redeemed their investments within one year prior to the public collapse in August 2005 of the Bayou hedge fund empire. Plaintiffs sue under Section 548(a) of the Bankruptcy Code, 11 U.S.C. § 548 (a), and Section 544 of the Code and Sections 273-76 of the New York Debtor and Creditor Law (“DCL”)
1
to recover as fraudulent convey-
*822
anees the amounts paid to these redeeming investors, including principal invested and “fictitious profits” fraudulently reported by the Bayou hedge funds’ prior management.
2
Jurisdiction
This Court has jurisdiction over these core adversary proceedings under 28 U.S.C. §§ 1334 (b) and 157(a) and (b)(2) and the standing order of reference to bankruptcy judges dated July 10, 1984 signed by Acting Chief Judge Robert J. Ward.
Overview of the Facts
The material facts as alleged in the amended complaints and as established by the evidence may be briefly summarized.
The original Bayou Fund was organized by Sam Israel, James Marquez and Daniel Marino in 1996. The Bayou Fund and its successor Bayou hedge funds were managed by Bayou Management LLC (“Bayou Management”), which was owned by Israel. From inception in 1996 through 2005 Israel served as the
de facto
Chief Executive Officer and Marino as the Chief Financial Officer of Bayou Management. The trading activity of the Bayou Fund and the successor Bayou hedge funds was conducted through a broker-dealer called Bayou Securities LLC (“Bayou Securities”), which was owned by Bayou Group, LLC.
Soon after the Bayou Fund started trading, it sustained losses. To conceal those losses, the Bayou Fund began falsifying its financial disclosures and fraudulently misrepresenting its investment performances. Because the Bayou Fund’s losses could not withstand the scrutiny of an independent audit, the Bayou Fund’s independent auditor was terminated and, in its place, Marino (an accountant) created a fictitious accounting firm (Richmond-Fairfield Associates, CPA, PLLC) to pose as the independent auditor.
From 1999 to 2003 the Bayou Fund continued to lose substantial amounts of money and never earned a profit, all the while drawing in millions of dollars of new investments. As a result of a reorganization in February 2003, the original Bayou Fund was liquidated and four separate onshore hedge funds were created, including the three Bayou hedge funds which are the debtor-plaintiffs in these adversary proceedings (the fourth new hedge fund was available only to Bayou employees and affiliates). Investors could exchange their investment in the original Bayou Fund for any of the three new Bayou hedge funds. Each of the new Bayou hedge funds subsequently sustained losses which were concealed through dissemination of false investment performance reports and false financial statements.
Beginning in 1999 and continuing through 2005 Israel and Marino caused the Bayou entities, under cover of purported “audits” by Richmond-Fairfield, to continue to generate false performance summaries and false financial statements designed to mislead investors. The Bayou hedge funds reported their performance returns to existing and prospective investors in weekly, monthly, quarterly and annual financial reports, individual investor monthly account statements, and in marketing materials. Plaintiffs have submitted as P-BAY Ex. 10 the Richmond-Fairfield certified financial statements of Bayou Fund for December 31, 2000, 2001 and 2002 and for the Bayou “Family of Funds” for the two years ending December 31, 2003 and 2004. Each of these year-end financial statements was preceded by a Richmond-
*823
Fairfield Associates cover sheet entitled “Financial Statements and Report of Independent Certified Public Accountants.” Each of these annual financial statements contained a covering letter on Richmond-Fairfield Associates letterhead stating:
We have audited the accompanying statement of financial condition, including the condensed schedule investments, of [the identified Bayou funds].
We conducted our audit in accordance with generally accepted auditing standards .... We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above, present fairly, in all material respects, the financial position of [the various Bayou funds] and the results of its operations, changes in its members’ capital and cash flows for the year then ended, in conformity with generally accepted accounting principles.
The representation that Richmond-Fair-field was an independent firm of certified public accountants was false. Each of the representations quoted just above was false. And as shown in the Lenhart Report described below, the financial data with respect to the Bayou hedge funds was false.
In addition to trading losses, the amended complaints alleged that the Bayou hedge funds were depleted for the personal financial benefit of the principals of Bayou. Millions of dollars in high volume trading commissions were paid to the broker-dealer Bayou Securities wholly owned by the principals, and millions of dollars of incentive bonus payments were made to the principals based on nonexistent profits.
3
Management of the Bayou hedge funds made a bank transfer of $120 million drawn from various Bayou accounts to a bank account in PostBank, Germany, of which $100 million was eventually deposited in a bank account in the United States. This bank account was seized by the Arizona Attorney General in May 2005, and the funds were eventually transferred to the United States Marshals Service for distribution
pro rata
to victims of the Bayou fraud.
During the summer of 2005 the Bayou entities finally collapsed. Despite assurance of full payment to the investors, the Bayou hedge funds did not repay any money to the then existing investor-creditors, who held approximately $250 million principal invested.
The terms governing redemptions of investments from the Bayou hedge funds were set forth in the Operating Agreement for each fund. Section 10.1 of each Operating Agreement provided that any investor was permitted to redeem the “whole or any part of the amount in his or its Capital Account at the end of any calendar month” upon fifteen days’ written notice. Under Section 10.4 of each of the Operating Agreements, after receipt of a redemption notice from an investor the particular Bayou hedge fund was required to pay “90% of the amount of [the investor’s] Capital Account withdrawn within thirty (30) days of the effective date of the withdrawal,” with “the balance of the amount due within thirty-one (31) days after the Company has received financial statements for the year ending as of the withdrawal date.”
The fraudulent conveyance claims asserted in these adversary proceedings seek to recover payments made to the defendant Bayou investors in purported redemption of part or all of their investment
*824
interests in the several Bayou hedge funds as reflected in the published financials for each of the funds. Since the financials fraudulently overstated the assets and failed to disclose the losses of the Bayou hedge funds and, therefore, overstated the investment accounts of all of the redeeming investors, the redemption payments in respect of greatly reduced or non-existent principal and fictitious profits exceeded the redeeming investors’ contractual entitlements.
Prior Motions to Dismiss
Defendants have previously made two motions to dismiss, both of which were denied by this Court. In the first, defendants in ninety-five adversary proceedings argued,
inter alia,
that the amended complaints failed to allege actual intent to defraud with sufficient particularity under Federal Rule of Civil Procedure 9(b) and failed to allege lack of good faith on the part of the defendants.
See In re Bayou Group, LLC,
362 B.R. 624 (Bankr.S.D.N.Y.2007)
(“Bayou
I”). In denying the motions, this Court addressed defendants’ misplaced reliance on a decision of the Court of Appeals for the Second Circuit in
Sharp International Corp. v. State Street Bank and Trust Company (In re Sharp International Corp.),
403 F.3d 43 (2d Cir.2005)
(“Sharp International
”) and a prior decision of this Court in
BalaberStrauss v. Sixty-Five Brokers (In re Churchill Mortgage Investment Corp.),
256 B.R. 664 (Bankr.S.D.N.Y.2000),
aff'd sub nom. Balaber-Strauss v. Lawrence,
264 B.R. 303 (S.D.N.Y.2001). Since this Court’s views on the relevance to these proceedings of the
Sharp International
and
Churchill
decisions have been fully explained in
Bayou I, see
362 B.R. at 636-638 , I shall not address defendants’ similar contentions on these motions.
In denying the second motion to dismiss filed on behalf of defendants in twenty-four adversary proceedings, this Court rejected arguments that the non-redeeming investors in the Bayou hedge funds are not creditors of the plaintiff hedge funds and a related argument under Section 510(b) of the Bankruptcy Code.
See In re Bayou Group, LLC,
372 B.R. 661 (Bankr.S.D.N.Y.
2007) (“Bayou II”).
Discussion
I.
Standards for summary judgment
Federal Rule of Civil Procedure 56(c) applies to bankruptcy proceedings by application of Rule 7056 of the Federal Rules of Bankruptcy Procedure and provides that summary judgment is proper “if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(c);
see Celotex Corp. v. Catrett,
477 U.S. 317, 322 , 106 S.Ct. 2548 , 91 L.Ed.2d 265 (1986);
Morenz v. Wilson-Coker,
415 F.3d 230, 234 (2d Cir.2005). The movant has the initial burden of demonstrating the absence of any genuine issue of material fact.
See Celotex,
477 U.S. at 323 , 106 S.Ct. 2548 .
In deciding whether material factual issues exist, the Court must resolve all ambiguities and draw all reasonable inferences against the moving party.
Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
475 U.S. 574, 587 , 106 S.Ct. 1348 , 89 L.Ed.2d 538 (1986). However, the existence of disputed issues of fact will not result in denial of a motion for summary judgment unless the disputed issues are material to the determination of the legal claims and defenses.
See Anderson v. Liberty Lobby, Inc., 477
U.S. 242, 248, 106 S.Ct. 2505 , 91 L.Ed.2d 202 (1986) (“Only disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment.”);
see also,
*825
Endico Potatoes, Inc. v. CIT Group/Factoring, Inc.,
67 F.3d 1063, 1066 (2d Cir.1995). If the record in its entirety could not lead a rational trier of fact to find for the non-movant, then no genuine issue remains for trial.
Matsushita,
475 U.S. at 587 , 106 S.Ct. 1348 .
Once the movant establishes its initial burden, the burden shifts to the non-mov-ant to establish that there is a specific and genuine issue of material fact to warrant a trial.
Celotex,
477 U.S. at 324 , 106 S.Ct. 2548 . The non-movant must “go beyond the pleadings and by [its] own affidavits, or by the ‘depositions, answers to interrogatories, and admissions on file,’ ” establish that there is a specific and genuine issue of material fact warranting a trial.
Celotex,
477 U.S. at 324 , 106 S.Ct. 2548 .
Conjecture, surmise or “metaphysical doubt” by the non-movant of the movant’s assertions will not defeat a summary judgment motion.
See Matsushita,
475 U.S. at 586 , 106 S.Ct. 1348 ;
see also, Bryant v. Maffucci,
923 F.2d 979, 982 (2d Cir.1991). Self-serving conclusory statements are also insufficient to defeat summary judgment.
See Ying Jing Gan v. City of New York,
996 F.2d 522, 532 (2d Cir.1993). The non-movant must present specific significant probative evidence supporting its case sufficient “to require a ... judge to resolve the parties’ differing versions of the truth at trial.”
Anderson, 477
U.S. at 249, 106 S.Ct. 2505 (citation omitted);
accord, Moratzka v. Visa U.S.A (In re Calstar, Inc.),
159 B.R. 247, 251 (Bankr.D.Minn.1993). “The mere existence of a scintilla of evidence in support of the [non-mov-ant’s] position will be insufficient; there must be evidence on which the jury could reasonably find for the [nonmovant].”
Anderson, 477
U.S. at 252, 106 S.Ct. 2505 .
The non-movant must present “substantial evidence” to overcome the motion, and the court must analyze “the evidence presented through the prism of the substantive evidentiary burden.”
Anderson, 477
U.S. at 250-54, 106 S.Ct. 2505 . “The non-movant must set forth specific facts that show triable issues, and cannot rely on pleadings containing mere allegations or denials.”
In re Teligent, Inc.,
337 B.R. 39, 43 (Bankr.S.D.N.Y.2005) (citations omitted). “If, however, the evidence tendered is ‘merely colorable,’ or is ‘not significantly probative,’ the non-moving party has not carried its burden and the court must grant summary judgment to the moving party.”
In re Calstar, Inc.,
159 B.R. at 252 (citation omitted).
II.
Section 548(a) issues and conclusions
A. The statute and case law
Plaintiffs’
prima facie
case for intentional fraudulent conveyance is governed by Section 548(a)(1)(A) of the Bankruptcy Code. Section 548(a)(1)(A) provides as follows:
(a) (1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debt- or in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or ...
Several observations may be made concerning this statute which are germane to the motions for summary judgment. Under Section 548(a)(1)(A) the
entire
amount of “any transfer” made with actual
*826
intent to hinder, delay or defraud creditors may be avoided. The entire amount is avoidable whether or not the debtor received value in exchange.
See, e.g., Sharp International,
403 F.3d 43, 56 (applying the analogous intentional fraudulent conveyance provision of New York law);
see Bayou I,
362 B.R. at 629 -30 and cases cited therein.
The malicious intent sufficient to support a cause of action is set forth in the disjunctive — a plaintiff may avoid the transfer where it was made with intent “to hinder, delay,
or
defraud” (emphasis added).
See Lippe v. Bairnco Corp.,
249 F.Supp.2d 357, 374 (S.D.N.Y.2003) (interpreting N.Y. Debt. & Cred. Law § 276 );
Flushing Sav. Bank v. Parr,
81 A.D.2d 655, 656 , 438 N.Y.S.2d 374 (N.Y.App.Div.1981),
appeal dismissed,
54 N.Y.2d 770 , 443 N.Y.S.2d 61 , 426 N.E.2d 752 (1981) (same); 5 Collier on Bankruptcy ¶ 548.04[1] at 548-23 (15th ed. rev.2006) and cases cited therein.
But see, e.g., Addison v. Seaver (In re Addison),
540 F.3d 805, 812-13 (8th Cir.2008). This malicious intent can be directed at either present or future creditors of the debtor as of the date of the transfer.
See
5 Collier on Bankruptcy ¶548.04[1] at 548-22.4 (15th ed. rev.2006). Thus, a plaintiff need not prove that the debtor intended to hinder, delay or defraud the transferee or any other particular creditor.
See id.
at 548-23. Also, the statute focuses on the debt- or’s “intent,” such that a plaintiff need not prove that the debtor actually did, in fact, hinder, delay or defraud the transferee or any other creditors.
See Brown v. Third Nat’l Bank (In re Sherman),
67 F.3d 1348 , 1355 (8th Cir.1995); 5 Collier on Bankruptcy ¶ 548.04[1] at 548-24 to 548-25 (15th ed. rev.2006).
4
Since the statute by its express terms applies only if “the debtor ... made such transfer with intent to hinder, delay, or defaud,” it is only the debtor’s intent that is relevant.
See, e.g., Sharp International,
403 F.3d 43, 56 (applying N.Y. Debt.
&
Cred. Law § 276 );
HBE Leasing Corp. v. Frank,
61 F.3d 1054 , 1059 n. 5 (2d Cir.1995) (same);
Andrew Velez Constr., Inc. v. Consol. Edison Co. of N.Y., Inc. (In re Andrew Velez Constr., Inc.),
373 B.R. 262, 269 (Bankr.S.D.N.Y.2007) and cases cited therein;
Picard v. Taylor (In re Park S. Secs., LLC),
326 B.R. 505, 517 (Bankr.S.D.N.Y.2005).
5
The intent of the
*827
transferee is not relevant except under the “good faith” defense of Section 548(c). In this sense Section 548 serves the same policy function as Section 547, which allows the trustee to avoid preferential payments made within ninety days of the bankruptcy to perfectly innocent creditors who were legally entitled to be paid. Both sections represent an equitable determination by Congress that under limited circumstances creditors must share equally in the insolvency, or, in the case of Section 548, the fraud. Section 548 is not a punitive provision designed to punish the transferee, but is instead an equitable provision that places the transferee in the same position as other similarly situated creditors who did not receive fraudulent conveyances.
It is well-settled that “actual intent to hinder, delay, or defraud” may be proven by circumstantial evidence — commonly referred to as “badges of fraud.”
See, e.g., Sharp International,
403 F.3d 43, 56 (applying N.Y. Debt. & Cred. Law § 276 );
Brown v. Third Nat’l Bank (In re Sherman),
67 F.3d 1348 , 1353 (8th Cir.1995);
Acequia, Inc. v. Clinton (In re Acequia, Inc.),
34 F.3d 800, 805 (9th Cir.1994);
Max Sugarman Funeral Home, Inc. v. A.D.B. Investors,
926 F.2d 1248, 1254 (1st Cir.1991),
remanded to
149 B.R. 274 (Bankr.D.R.I.1992). It is sufficient for a plaintiff to demonstrate that the trans-feror “acted under circumstances that preclude any reasonable conclusion other than that the purpose of the transfer was fraudulent as to creditors.” 5 Collier on Bankruptcy ¶ 548.04[1] at 548-26 (15th ed. rev. 2006) (citing
Lesser v. Jewel Factors Corp.,
470 F.2d 108, 110 (2d Cir.1972)).
The plaintiffs’
prima facie
case for constructive fraudulent conveyance is governed by Section 548(a)(1)(B). Section 548(a)(1)(B) provides in pertinent part that the trustee can avoid a transfer “if the debtor voluntarily or involuntarily” [omitting new subsection (IV) ]:
(B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
(II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; or ...
The burden is on the plaintiff to prove that the transferee received less than reasonably equivalent value and that the debtor was insolvent as of the date of the transfer, undercapitalized or in-tended to incur debts beyond its ability to repay. It has been previously held as a matter of law, and there is no dispute here, that the defendants gave reasonably equivalent value for their redemptions to the extent of their original investments.
See Bayou I,
362 B.R. at 634 . Accordingly, the plaintiffs’ constructive fraud claims under Section 548(a)(1)(B) are limited to any ficti
*828
tious profits which were paid to any of the defendants.
B.
The evidence: criminal pleas/allo-cutions and the Lenhart Report
Plaintiffs’ evidence in support of their claims of actual and constructive fraudulent conveyance under Section 548(a)(1)(A) and (B) consists of two elements. One is comprised of the guilty pleas and allocu-tions of Israel, Marino and a third principal of Bayou, James Marquez, who resigned from Bayou in October 2001. The other element consists of the Expert Report of William K. Lenhart (the “Lenhart Report”) and the Exhibits to and documents underlying it, all of which were timely provided to defendants’ attorneys. The evidence overwhelmingly establishes the Bayou fraud alleged in the amended complaints.
1.
What the evidence shows
(a)
Guilty pleas and allocutions
The guilty plea and allocution of Israel appears in the transcript of proceedings in the District Court dated September 29, 2005 marked as P-BAY Ex. 1. At this hearing Israel pleaded guilty to the Assistant United States Attorney’s recitation of the charges in the information. After noting that Bayou sustained trading losses during the relevant period from approximately 1999 through mid-summer 2005, the prosecutor recited the following allegations: “[t]he defendant and co-conspirators ... perpetrated a scheme to defraud investors by disseminating reports and financial statements among other things that contained materially false statements and by failing to invest investors’ funds as promised.” PBAY Ex. 1 at 18. In describing the mail fraud count of the information, it was alleged that Israel “knowingly and willfully participated in the scheme or artifice to defraud with knowledge of its fraudulent nature and with a specific intent to defraud.”
Id.
at 15.
In order to establish the elements of these crimes, the government would prove at trial, based on documentary evidence and testimony of witnesses, that during the time period set forth in the information, Samuel Israel and his co-conspirators perpetrated a fraud on investors and prospective investors of the Bayou Hedge Funds by misrepresenting the value of the Hedge Funds’ assets, and including these misrepresentations to be mailed to current and prospective investors in the Southern District of New York and elsewhere. These false and misleading statements and representations induced new investors to invest in Bayou and lulled existing investors into retaining their investments in the Bayou Hedge Funds.
Id.
at 15-16.
In furtherance of the scheme and because Bayou could not use an actual certified public accounting firm to audit the funds and certify the annual financial statements, Mr. Israel had his co-conspirator and chief financial officer in early 1999 form a phony accounting firm name [sic] Richmond Fairfield Associates. And year after year between 1999 and 2004, the co-conspirators had Bayou’s false financial statements sent out with a fictitious certification by Richmond Fairfield Associates that the funds had been audited and the financial statements were accurate.
Id.
at 16.
[Israel] and his co-conspirators caused to be mailed quarterly reports to investors that contained fictitious rates of return on trading in the funds and annual financial statements that contained fictitious rates of return on trading and inflated net assets [sic] values. Mr. Israel and his co-conspirators also had
*829
faxed and mailed weekly newsletters that also misrepresented the performance of the funds at various times during the time period set forth in the information. All these communications to investors made it appear that Bayou was earning profits on trading when in fact it was not.
Id.
The prosecutor charged that Israel and a co-conspirator carried out the conspiracy to defraud by reporting “fictitious rates of return by the Bayou Hedge Funds” in quarterly reports, weekly newsletters, monthly reports and annual financial statements mailed or faxed to investors.
Id.
at
18. The annual financial statements “contained among other misrepresentations, inflated rates of return on trading, inflated net asset values, and certifications that Bayou had been audited by a certified public accounting firm known as Richmond Fairfield Associates.”
Id.
at 18-19. The prosecutor charged that “[i]n or about early 1999, a co-conspirator created the phony accounting firm Richmond Fairfield Associates and it conducted no audits.”
Id.
at 19. “Between in or about the fall of 2008 and in or about August 2005, Israel and a co-conspirator entered and attempted to enter into private financial transactions using money from the Bayou Hedge Funds without disclosing the nature of those transactions to investors.”
Id.
“From in or about July 1996 through in or about August 2005, Israel and his co-conspirators induced investors to contribute in excess of $450,000,000 to the Bayou Hedge Funds.”
Id.
After pleading guilty to the several counts of the information, Israel described in his own words and in response to questions the types of conduct to which he pleaded guilty. He testified that during the relevant time period he was the chief executive officer of Bayou Management and chief investment officer of the Bayou Fund and was responsible for trading securities on behalf of all of the funds.
Id.
at 24. Israel, along with others
caused Bayou to send various kinds of documents containing false financial information about Bayou’s performance to current and prospective clients of Bayou which made it appear that Bayou was performing better than it truly was. My purpose was to induce these people to invest in Bayou or continue to keep their money in Bayou.... At the time that Bayou sent out these false materials, I knew that the terms were false and I knew what I was doing was wrong and fraudulent.
Id.
The hearing on Marino’s guilty plea and allocution also took place in the District Court on September 29, 2005. The transcript of the hearing is marked as P-BAY Ex. 2. The recitations of the Bayou scheme to defraud using weekly, monthly, quarterly and annual reports and financial statements were substantially identical to the allegations to which Israel plead guilty. After pleading guilty to the several counts in the information, Marino testified in his own words
As set forth in the information, I did participate as chief financial officer of Bayou in a conspiracy and a course of conduct along with other individuals to mislead investors in the Bayou Hedge Fund by sending them false information regarding the true status of their investment. The communication to investors was sent by mail and by wire, intended to mislead investors. I did not act alone when I committed these offenses. At the end of 1998, we all agreed to set up an accounting firm that would give the appearance of an independent auditor to further the conspiracy to deceive Bayou investors. I did form Richmond Fair-
*830
field Associates which certified a false financial statement of Bayou as true.
P-BAY Ex. 2 at 27-28.
The guilty plea and allocution of Marquez was recorded at a hearing in the District Court on December 14, 2006. Summarizing elements of the crimes alleged in the information, the Assistant United States Attorney stated that from July 1996 until October 10, 2001 Marquez, Israel and Marino “perpetrated a fraud on investors and potential investors ... by misrepresenting the value of the hedge funds’ assets and causing these misrepresentations to be disseminated to current and prospective investors in the Southern District of New York and elsewhere.” P-BAY Ex. 3 at 15.
[Marquez] and his co-conspirators caused to be mailed quarterly reports to investors that contained fictitious rates of return on trading in the funds and annual financial statements that contained fictitious rates of return on trading and inflated net asset value. The evidence would establish that Mr. Marquez and Mr. Israel made up numbers. All of these communications to investors made it appear that Bayou was earning profits on trading when, in fact, it was not.
Id.
at 16. In his own words, Marquez testified:
Your Honor, during the period of time alleged in the information, I acted in the position of a portfolio manager for Bayou Fund where I helped formulate the trading strategy for the fund. I had general knowledge of the financial status of the fund and became aware, after a period of time, that the fund was sustaining losses.
Together with others, I caused documents to be sent via U.S. Mail to investors that contained inaccurate financial information about the Bayou Fund. Specifically, such mailings contained false financial information that made it appear that the fund was more successful than it actually was.
I was also aware that Richmond-Fair-field was formed to handle the audits for the Fund with the intent that the true financial statement of the Fund not be disclosed to investors.
Id.
at 20.
Israel, Marino and Marquez have all been sentenced to lengthy prison terms for their crimes. Their guilty pleas and allo-cutions establish the following facts:
• During the relevant period from at least 1998 through August 2005 the Bayou Fund and the successor Bayou hedge funds sustained trading losses.
• In late 1998, Israel, Marino and Marquez conceived a scheme to defraud existing and potential Bayou investors by means of creating a fictitious, purportedly independent firm of certified public accountants. Marino established the fictitious firm of Richmond-Fairfield Associates, and for the years 1999 through 2004 Israel, Marino and (until October 2001) Marquez caused false annual financial statements to be certified by Richmond-Fairfield. In fact, Richmond-Fairfield did not conduct any audits of the Bayou financial statements.
• During the relevant period the Bayou principals caused Bayou to issue weekly, monthly and quarterly reports and annual financial statements which falsely overstated the Bayou Fund’s and the successor Bayou hedge funds’ earnings and net asset values and the net asset values of the individual investors. In fact, Israel and his co-conspirators simply “made up numbers.”
• Israel, Marino and Marquez knowingly published the fraudulent periodic reports and annual financial statements with the intention of misleading exist
*831
ing and prospective investors in order to induce them to retain their Bayou investments and invest new money in the Bayou hedge funds.
(b)
The Lenhart Report
When the Bayou debtors, including the three plaintiff Bayou hedge funds, filed their Chapter 11 petitions in this Court, they had no material trade or borrowing debt. The creditors of these debtors’ estates are the defrauded investors who did not redeem their investments, augmented post-petition by those investors who redeemed pre-petition, settled fraudulent conveyance claims asserted against them by plaintiffs and thereby became creditors to the extent of their redemptions of principal invested repaid to the debtors’ estates.
All investors in the Bayou hedge funds were creditors of the particular funds in which they invested in two separate ways. First, under the terms of the Operating Agreement for each of the Bayou funds each investor had the contractual right to redeem part or all of his account balance in the fund, limited to his
pro rata
share of the net asset value of the fund. Second, as a consequence of the pervasive fraud described in the guilty pleas and allocutions of the Bayou principals, all investors in the Bayou funds have or had tort claims for rescission of the entire amount actually invested in the funds, although not including fictitious profits reported in the fraudulent financial statements.
6
To establish their fraudulent conveyance claims in these adversary proceedings, it was incumbent on plaintiffs to perform a solvency analysis to enable the Court to determine whether or not the Bayou hedge funds were solvent during the relevant period. Reduced to essentials, the fundamental issue in any such analysis is whether the net asset values (NAVs) of the Bayou hedge funds were less than, equal to or greater than the amounts actually invested in the funds by the investors. To perform this analysis plaintiffs retained William K. Lenhart, CPA, CIRA, CTP, CFE (“Lenhart”), through his firm BDO Seidman, LLP (“BDO”).
The Lenhart Report is comprised of a table of contents, pages of text numbered 3-39 and thirty-five Exhibits numbered Exhibit 1 through Exhibit 14 (a number of exhibits are broken into separate parts,
e.g.,
Exhibit 6.A, Exhibit 6.B,
etc.).
All underlying documents on which the Exhibits are based
(e.g.,
monthly statements for accounts at Citibank, Cornerstone and Wa-chovia, brokerage statements of Spear, Leeds & Kellogg, Weis, Peck and Greer,
etc.)
were made available to counsel for all defendants. Based upon his professional credentials (set forth at pages 4-5 of his Report and Exhibit 3), I have concluded that Lenhart is eminently qualified to serve as an expert witness for the purpose of preparing and rendering his Report and expressing his conclusions therein.
At the outset of his Report, under the heading “Summary of Opinions,” Lenhart described his task as follows:
I undertook an assessment of the Bayou Funds’ financial condition to determine whether the Bayou Funds were insolvent at, or as of, a particular time, or whether they became insolvent as a result of substantial trading losses, defalcations, and certain transfers,
i.e.,
the redemptions by certain investors during the Testing Period [January 1, 2002 to August 31, 2005];[ ] whether these loss
*832
es and transfers left the Bayou Funds with unreasonably small capital or assets for the business; or whether the Bayou Funds intended to incur debts beyond their ability to pay such debts as they became due. In this Report, I have undertaken the analysis of three recognized forms of financial distress that include: (1) an adjusted balance sheet test; (2) an insufficient capital or assets test; and (3) an inability to pay debts as they become due test. Each method provides a different, but related, perspective on the question of solvency or financial distress and must be considered in developing a profile of the Debtors’ financial condition during the Testing Period. A description and the results of these tests are discussed in Part VII.
Lenhart Report 6. The Summary continues with an explanation of the conservative approach employed by Lenhart with respect to the determination of net asset values:
In my analysis and in the formulation of my opinions, I used an approach that should result in an overstatement of net asset values (“NAV”)
6
in these circumstances. For example:
• I did not limit my calculation of the Bayou Funds’ NAV to those assets held in the name of the Bayou Funds. Instead, based on the best available financial information, I considered all assets of the Fund and Non-Fund Entities known to me in order to take into consideration the commingling of assets between the Bayou Funds and Non-Fund Entities and among the bank and investment accounts of the various entities, the unwinding of which would probably not be possible and, at the very least, would be both prohibitively expensive and time consuming.
• My NAV calculation does not make any provision for liabilities, such as, obligations to repay loans, any obligation to return funds to offshore entities, or, any accrued operating or other expenses.
The “Excess (Deficit)” representing the amount by which “Investor Ending Balances (Contributions less Redemptions)” exceeded total Bayou entity assets, as reflected on the chart at page 35 of the Lenhart Report, was as follows: for 2002 ($57,246,421); for 2003 ($120,557,826); for 2004 ($215,335,110); for August 31, 2005 ($218,745,730). The Fair Value Adjusted Balance Sheets show that, even increasing the Bayou entity assets by “Total Other Items for Consideration” (discussed further under defendants’ objections to admissibility, below), Bayou Fund and its successor Bayou hedge funds were insolvent to the extent of the following deficits: for 2002 ($51,776,411); for 2003 ($117,960,-
*833
120); for 2004 ($95,893,019); for August 31, 2005 ($108,388,100). For convenience I shall refer to this latter set of deficit numbers as the “Minimum Insolvency Figures.”
Lenhart’s conclusion with regard to “Redemption Payments to Defendants” in Section B of Section VII was as follows:
As discussed in the “Investor Activity/Balances” section of this Report, we calculated the
pro-forma
month-end balances for each investor based on their actual contribution and redemption data. In place of allocating the fictitious periodic profits, I developed the approach of performing a
pro rata
allocation of the monthly change in the NAV to each investor to arrive at the
pro-forma
month-end balance for each investor.
Exhibit 13
quantifies the results of this calculation for each Defendant. It is my opinion that (1) each of the redemption payments made by the Bayou Funds to Defendants on or after May 30, 2004 was based on the Defendant’s individual account balances as reported by the Bayou Funds to investors and was within 10% of “Members’ Capital” as reported by the Bayou Funds in its fraudulent financial statements as at December 31, 2002, 2003 and 2004; (2) each such redemption payment was made based on a reported account balance for such Defendant that was inflated above what should have been the value of the Defendants’ Bayou Funds’ account and bore no relationship to the Bayou Funds’ financial condition or value; and (3) each such redemption payment was made at the time when the Bayou Funds did not have sufficient assets to pay all of its investors their reported account balances or even repay their principle [sic] investments. In fact, during my investigation, we were unable to uncover any information or accounting that justified or even attempted to justify the reported account balances for the Defendants used by the Bayou Funds to support the redemptions at issue in these Adversary Proceedings.
Id.
at 37-38.
Lenhart’s ultimate conclusion in Section VIII of the Report is as follows:
It is my opinion that during the Testing Period, the Bayou Funds were insolvent on an adjusted balance sheet basis, were operating with inadequate capital, and did not have the ability to pay debts as they became due. Furthermore, it is my opinion that each redemption payment was made based on a reported account balance for such Defendant that was inflated above what should have been the value of the Defendants’ Bayou Funds’ account and bore no relationship to the Bayou Funds’ financial condition or value. Indeed, the amount that such payments were inflated is consistent with the values reported to investors and the fraudulent financial statements.
Id.
at 38.
It is important to note here that the defendants have not proffered any evidence to show that the Minimum Insolvency Figures documented by Lenhart were wrong, much less that the Bayou hedge funds were actually solvent at any time. Of course, the burden is on plaintiffs to prove their case. But as shown in point I, above, when the party moving for summary judgment has submitted evidence documenting its
prima facie
case, the opposing party cannot rely on denials, self-serving arguments or “metaphysical doubt,” but must present “evidence on which the jury could reasonably find for [the opposing party].”
Anderson,
477 U.S. at 252 , 106 S.Ct. 2505 . Defendants have had ample opportunity to conduct their own investigation, to conduct discovery and to submit evidence demonstrating that there is a genuine dispute as to any of the findings and conclusions in the Lenhart
*834
Report. But they have not tendered any such evidence in opposing plaintiffs’ motion for summary judgment with respect to Section 548(a) claims.
Based on the Lenhart Report and Exhibits, the Lenhart Declaration and Exhibits and the failure of defendants to submit any evidence in support of an argument that there is a
bona fide
factual dispute with Lenhart, I accept the findings and conclusions set forth in the Lenhart Report as established in these adversary proceedings, and I conclude that the Bayou hedge funds were insolvent during the relevant period to the extent of at least the Minimum Insolvency Figures. Further, I conclude that each redemption payment (i) was based on the inflated values reflected on the fraudulent financial statements, reports and individual investor accounts and (ii) exceeded the amounts to which each redeeming investor was contractually entitled.
2.
Admissibility
(a)
Guilty pleas and allocutions
The law is clear that the guilty pleas and allocutions of Israel, Marino and Marquez in evidence are admissible to prove the truth of their contents in these civil proceedings. Guilty pleas and plea allocutions in criminal cases are admissible evidence in subsequent civil proceedings.
See
Fed.R.Evid. 803(22) and 807. While the general bar to hearsay evidence is defined in the “Hearsay Rule” of the Federal Rule of Evidence which states that “Hearsay is not admissible except as provided by these rules or by other rules prescribed by the Supreme Court pursuant to statutory authority or by Act of Congress,” Fed.R.Evid. 802, applicable exceptions can be found in Rules 803(22) and 807 which provide as follows:
Rule 803. Hearsay Exceptions; Availability of Declarant Immaterial
(22) Judgment of previous conviction. Evidence of a final judgment, entered after a trial or upon a plea of guilty (but not upon a plea of nolo contendere), adjudging a person guilty of a crime punishable by death or imprisonment in excess of one year, to prove any fact essential to sustain the judgment, but not including, when offered by the Government in a criminal prosecution for purposes other than impeachment, judgments against persons other than the accused. The pendency of an appeal may be shown but does not affect admissibility.
Rule 807. Residual Exception
A statement not specifically covered by Rule 803 or 804 but having equivalent circumstantial guarantees of trustworthiness, is not excluded by the hearsay rule, if the court determines that (A) the statement is offered as evidence of a material fact; (B) the statement is more probative on the point for which it is offered than any other evidence which the proponent can procure through reasonable efforts; and (C) the general purposes of these rules and the interests of justice will best be served by admission of the statement into evidence. However, a statement may not be admitted under this exception unless the proponent of it makes known to the adverse party sufficiently in advance of the trial or hearing to provide the adverse party with a fair opportunity to prepare to meet it, the proponent’s intention to offer the statement and the particulars of it, including the name and address of the declarant.
The cases so hold.
See Scholes v. Lehmann,
56 F.3d 750, 762 (7th Cir.1995),
cert. denied sub nom. African Enterprise, Inc. v. Scholes,
516 U.S. 1028 , 116 S.Ct. 673 , 133 L.Ed.2d 522 (1995) (Ponzi scheme
*835
principal’s admission of fraud in criminal plea agreement is admissible evidence in subsequent fraudulent conveyance action to recover from transferee “through hearsay, Fed.R.Evid. 803(22) ...” (citations omitted));
Bear, Stearns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund, Ltd.),
2007 WL 4440360, at *8 (S.D.N.Y. Dec.17, 2007) (“the criminal information to which [principal of a hedge fund] pled guilty” was recognized as “ample support in the record [to establish the] characterization” of a Ponzi scheme in subsequent proceeding);
American Int’l Specialty Lines Ins. Co. v. Towers Fin. Corp.,
1997 WL 906427 , at *4 n. 7 (S.D.N.Y. Sept.12, 1997) (“... plea allocutions are admissible [against a third party in subsequent civil proceeding] pursuant to Fed.R.Evid. 803(22), which makes non-hearsay ‘[e]vidence of a final judgment, entered after trial or upon a plea of guilty ..., adjudging a person guilty [of a felony], to prove any fact essential to sustain the judgment ... ’ ” (citations omitted)).
Courts have consistently found that criminal proceeding admissions of a fraudulent scheme to defraud investors made in guilty pleas and plea allocutions are admissible as evidence of “actual intent” to defraud creditors.
See Rosen v. Neilson (In re Slatkin),
310 B.R. 740, 748 (C.D.Cal.2004),
aff'd,
222 Fed.Appx. 545 (9th Cir.2007)
(“direct
evidence” of “actual intent to defraud” was found in admission in plea agreement that transferor “executed a scheme to defraud approximately 800 investors throughout the United States of over $593 million, and to obtain money and property from such investors by making and causing materially false statements to be made to such investors and by concealing material facts from them.”);
Scholes v. Lehmann,
56 F.3d at 762 (in a subsequent fraudulent conveyance action against a transferee, Ponzi scheme principal’s admission of fraud in prior criminal plea agreement was sufficient to establish liability);
Bauman v. Bliese (In re McCarn’s Allstate Fin., Inc.),
326 B.R. 843, 851 (Bankr.M.D.Fla.2005) (actual intent to defraud is established “... if the allegations in the information establish that the debtor ran a scheme whereby the debtor intended to defraud the debtor’s creditors, evidence of a guilty verdict or plea agreement admitting the charges can establish the existence of a Ponzi scheme.... As the case law above recognizes, a debtor who runs a Ponzi scheme knows that his future investors will lose their money and ‘a debtor’s knowledge that future investors will not be paid is sufficient to establish his actual intent to defraud them.’” (citations omitted));
Emerson v. Maples (In re Mark Benskin & Co., Inc.),
161 B.R. 644, 648-49 (Bankr.W.D.Tenn.1993) (“The debtors’ intent to defraud creditors was established by the guilty pleas to the related criminal charges [including the scheme by principal and solely controlled company to defraud creditors] and preclusive effect may be given to those guilty pleas as factual findings to the extent that the debtors’ intent to defraud creditors is required in this adversary proceeding.”).
Defendants do not dispute the admissibility of the guilty pleas and allocutions.
(b)
The Lenhart Report
Defendants have strenuously disputed the admissibility of the Lenhart Report in a motion to exclude, which I previously denied, and in opposing plaintiffs’ motions for summary judgment. The following is a brief summary of defendants’ objections to admissibility of the Lenhart Report and my reasons for overruling the objections.
• Lenhart’s qualifications.
Lenhart’s extraordinary qualifications detailed in his Report and annexed
curriculum vitae
speak for themselves and need not be recited here. Suffice it to say that he has
*836
practiced public accounting for over twenty-five years, has been designated a Certified Public Accountant, Certified Insolvency and Restructuring Advisor, Certified Turnaround Professional and Certified Fraud Examiner, has acted as a forensic accounting expert in many engagements, has wide experience in the field of insolvency, and has acted as a court-appointed examiner and an Independent Examiner approved by the Securities and Exchange Commission.
The fact that Lenhart had not previously been engaged to examine the solvency of a hedge fund in no way supports defendants’ argument that he is not qualified to do so. There is nothing mystical or esoteric about a hedge fund which distinguishes it from other species of business and financial enterprise. The fundamental tasks here were to examine all of the available source documents and from these determine, quantify and correlate on an ongoing, month-by-month basis during the Testing Period the universe of assets of all of the Bayou entities; the universe of liabilities of the Bayou hedge funds against which the total assets are to be measured (which in this case consisted solely of the principal contributed by the investors in the Bayou hedge funds net of redemptions); the inflated NAVs as reported in the fraudulent financial statements and other periodic reports disseminated by Bayou Management; and the amounts paid out by the Bayou hedge funds to investors who redeemed their investment accounts.
Lenhart’s credentials as reflected in his
curriculum vitae
and his work product as reflected in the Report, the Declaration and the Exhibits thereto amply support the conclusion that it would be difficult to find a better qualified expert to perform these tasks of compilation, correlation and analysis.
• Lenhart Report unsworn.
Defendants argue that the Lenhart Report is not admissible as evidence because it was un-sworn. The Lenhart Report was signed by Lenhart, set forth in detail his findings and conclusions, identified the source documents upon which he relied and included his
curriculum vitae,
in accordance with the requirements of Rule 26(a)(2)(B) of the Federal Rules of Civil Procedure. Defendants had a full and fair opportunity to, and did, conduct a deposition of Lenhart under oath in which he repeatedly endorsed the Report and responded to all questions concerning it. Lenhart signed and submitted his Declaration “under penalty of perjury” dated May 12, 2008, in which he stated “I affirm that the Expert Report and the deposition testimony I gave related thereto were truthful at the time given and continue to be true and accurate, subject to this declaration (‘Declaration’), which in no way impacts the conclusions or opinions as set forth in my original Expert Report. I further affirm that the information in this Declaration is also true and accurate.”
If Lenhart’s failure to sign the Expert Report subject to the penalties of perjury could be deemed a defect, the defect was cured by his subsequent deposition and Declaration.
See Maytag Corp. v. Electrolux Home Prods., Inc.,
448 F.Supp.2d 1034, 1064 (N.D.Iowa 2006) (“This Court concludes that subsequent verification or reaffirmation of an unsworn expert’s report, either by affidavit or deposition, allows the court to consider the unsworn expert’s report on a motion for summary judgment.”),
aff'd
224 Fed.Appx. 972 (Fed.Cir.2007);
Capobianco v. City of New York,
422 F.3d 47, 55 (2d Cir.2005) (“Had [plaintiff] been given notice that [lack of verification] was an issue, [plaintiff] could have obtained an affidavit easily, as Dr. Brodie had already been designated an expert and his expert report had previously been produced.”);
Straus v. DVC Worldwide, Inc.,
484 F.Supp.2d 620 , 634
*837
(S.D.Tex.2007) (expert report properly authenticated by a sworn declaration filed while summary judgment motion was pending).
• Relevance.
While defendants’ other objections may fairly be characterized as trivial or frivolous, the Sonnenschein Investors’ argument that “The Lenhart Report is Not Relevant” (Memorandum 13
et seq.)
is simply incomprehensible. Defendants may assert defects in the Report and disagree with Lenhart’s findings and conclusions, but it cannot be argued intelligibly that the Report is not “relevant.” The argument concludes:
The Lenhart Report ... assumes insolvency using the facts, method and conclusions pulled together by Lenhart in support of the actual fraud claims. There is, then, no legitimate report on insolvency or establishing otherwise the financial elements of constructive fraud.
Id.
at 15. To the contrary, the Lenhart Report does not “assume” insolvency — it proves insolvency using the actual financial data derived from all available source documents to show both actual assets and actual amounts invested. Further, by contrasting the actual value of the Bayou entities’ assets with the NAVs of the Bayou hedge funds as fraudulently represented by Bayou Management, and by comparing the redemption payments with the redeeming investors’ fraudulently inflated account statements and correspondingly fraudulently inflated NAVs for the various funds, the Lenhart Report demonstrates the existence of both actual fraud and constructive fraud during the Testing Period and confirms the actual fraud confessed by Israel, Marino and Marquez in their guilty pleas and allocutions. These are precisely the issues raised by plaintiffs’ claims in these adversary proceedings. It is ludicrous to say that the Report is not relevant.
•
Methodology.
Defendants acknowledge that “[t]he Lenhart Report invokes the standard methodology for determining solvency.” Sonnenschein Investors’ Exclusion Memorandum at 16. But they argue that the Report “fails to apply it and/or fails to apply it in accordance with other experts in this area.”
Id.
A purported example of failure to apply proper methodology is the argument that “Lenhart does not go through the exercise of reconstructing a balance sheet reflecting assets and liabilities of the plaintiff at fair valuation at the time of the transfer.”
Id.
at 17. This assertion ignores the Fair Value Adjusted Balance Sheets and is contradicted in the very next sentence of the Memorandum which states that “the Lenhart Report aggregates cash balances for select bank and brokerage accounts with Reconstructed Account Balances and assets held by Bayou Fund Affiliates (valued at cost) on a month by month basis, and then sets off against that amount the aggregate full principal amount of investor contributions less redemptions that month to come up with a negative balance.”
Id.
The fact is that Lenhart’s balance sheet approach is quite conventional, aggregating all assets (cash and investments) of all the Bayou entities (not just the Bayou hedge funds) and balances total assets thus determined against liabilities (but only tort liabilities based upon investors’ capital contributions, excluding any other liabilities), which showed that assets so determined exceeded liabilities so determined.
Defendants erroneously argue that Len-hart’s conclusions were “built upon a proof of cash process, not on the balance sheet test.”
Id.
at 16. In fact, Lenhart validated the actual Bayou NAVs by performing a “proof of cash” test to ensure that he had accounted for all of Bayou’s assets during the relevant period. In this regard, he
*838
analyzed and accounted for all significant inflows of cash to verify that Bayou did not liquidate any assets it had held during the relevant period but which were left out of Lenhart’s NAV calculations, and thus he was able to conclude that he had accounted for all of Bayou’s assets. Lenhart’s “proof of cash” method was a balance sheet test. Lenhart’s method was to identify and account for all of Bayou’s assets, which were compared to Bayou’s tort liabilities to investors. This comports with the defendants’ own articulation of a balance sheet test as a test of “whether the debtor’s assets were greater than the debtor’s liabilities.”
Id.
The defendants complain about the Len-hart Report’s consolidation of the Bayou assets and liabilities. Because the Bayou entities commingled assets and failed to respect the corporate form, the Lenhart Report conservatively included all known assets of all of the Bayou entities when calculating Bayou’s NAV for each month, even though the liability to repay unredeemed investor principal only belonged to the specific Bayou hedge fund. Defendants assert that Lenhart “paid lip service to substantive consolidation” by consolidating the debtors’ assets and liabilities “when it was helpful to his case” and by keeping “them separate when it was not helpful to consolidate.”
Id.
at 24. Specifically, defendants argue that Lenhart “made no attempt to consolidate the assets of the principals although it was clear that they were obtained with cash from the Bayou Funds.”
Id.
However, the defendants have not identified any of these assets that were allegedly “obtained with cash from the Bayou Funds” (other than the $120 million wired overseas) or provided any reason to believe that, even if they exist, they were not simply stolen from Bayou and hence could no longer be included on Bayou’s balance sheet under Bankruptcy Code Section 101(32)(A)(i).
As amplified below, to the extent that the exclusion of a major item (the $120 million wire transfer to Europe) or the valuation at cost of certain assets (certain private equity investments) involved an exercise of professional judgment, the assets and issues were fully disclosed in the Report and the Declaration and fully accounted for in the line item for “Other Items for Consideration” on the Fair Value Adjusted Balance Sheets.
Another methodology plaint is the argument that “the treatment of the investor contributions as liabilities through the Report, rather than as equity, is a departure from the standard methodology.”
Id.
at 17. Of course, in an ordinary corporate balance sheet solvency analysis equity interests in the corporation do not constitute liabilities and are not treated as such on the balance sheet. But the Bayou hedge funds were not ordinary corporations, the tort liability of the Bayou hedge funds to their investors based upon rescission for fraud was not analogous to shareholder equity interests in a corporation, and this was not an ordinary corporate solvency analysis. Unlike a corporation which has no liability to its shareholders, it is a given in these adversary proceedings (which both sides must and do acknowledge) that the Bayou hedge funds had a legal tort liability to their investors for the full amount of their investments based on rescission for fraud. As such, the investors were and are creditors.
See Bayou II,
372 B.R. at 664-665 . The purpose of the Len-hart solvency analysis was precisely to determine whether the Bayou hedge funds’ liability to their investors was backed by assets.
The defendants take issue with the fact that Lenhart allegedly failed to utilize generally-accepted accounting principles (“GAAP”) at various points in his Report. Putting aside the fact that the
*839
Report generally does utilize GAAP, “the law does not require compliance with generally accepted accounting principles in performing a solvency analysis.”
Sharp v. Chase Manhattan Bank USA, N.A. (In re Commercial Fin. Servs.),
350 B.R. 520 , 539
&
n. 15 (Bankr.N.D.Okla.2005). Even the defendants’ own expert, who takes issue with Lenhart’s failure to use GAAP, has previously testified that GAAP is immaterial to the question of solvency.
See Silverman v. Paul’s Landmark, Inc. (In re Nirvana Rest.),
337 B.R. 495, 507 (Bankr.S.D.N.Y.2006) (“Kranzler testified that GAAP was immaterial to the question of solvency”).
Cf.
Kranzler Report at 7-8.
Lenhart did, in fact, depart from standard methodology in several respects, but all such departures had the effect of overstating net asset values or understating liabilities. For example, Lenhart included not only assets held in accounts in the name of the Bayou hedge funds, but also assets held in the name of all other Bayou entities; Lenhart excluded all liabilities of the Bayou hedge funds and the other Bayou entities other than the Bayou hedge fund tort liabilities to investors for rescission of amounts invested; Lenhart included in assets $37 million in cash from investors in the Bayou offshore hedge funds without reducing the asset by a corresponding liability to the offshore funds.
In short, there is no basis to exclude the Lenhart Report on the ground of any deviation from standard accounting analysis or methodology.
• No investigation.
Defendants complain that Lenhart and his firm BDO did not conduct an independent investigation concerning such matters as the $120 million wired to a PostBank account in Germany in July 2004, or what happened to $20 million of $120 million, or to locate other possible assets of the Bayou entities. It is argued that “[g]iven the absence of a true investigation into the assets of the Bayou Funds, it is impossible to determine at this stage and on this record whether the misrepresentations were ‘material.’ ” Freestone Memorandum at 10. The short answer to these contentions is that Len-hart was not hired to conduct an investigation. The task assigned to and performed by Lenhart and BDO was to review and analyze all of the known source materials documenting the assets and liabilities of all the Bayou entities. This they did. It is and has always been in the interests of the plaintiff Bayou hedge funds, their creditors and all of the defendants in these adversary proceedings to investigate and discover any and all assets of any of the Bayou entities for distribution to the defrauded investors/ creditors. But Lenhart and BDO were not retained to do that. The fact that they did not conduct an independent investigation to discover or track assets not reflected in the compendious source documents of these debtors does not render the Report which they were commissioned to prepare inadmissible.
•
Third-party litigation claims.
Defendant Freestone argues that the Lenhart Report erroneously “failed to include as assets the claims against earlier redeemers and partial redeemers on the same legal theories as those brought against the current defendants,” and omitted a claim asserted in an adversary proceeding (removed to the District Court and now in arbitration) against the successor-in-interest to Spear, Leeds & Kellogg, which served as a broker-dealer on behalf of the Bayou hedge funds (the “SLK claim”). The fraudulent conveyance claims against redeeming investors asserted in these adversary proceedings are expressly excluded from assets for the purpose of determining insolvency under Section 101 (32)(A)(i) of the Bankruptcy Code. The SLK claim may or may not be meritorious, but there was no basis for Lenhart to include as an asset for determining solven
*840
cy such a claim asserted years after the relevant Testing Period. Moreover, the SLK claim, asserted in the gross amount of $20 million, would not materially affect the Minimum Insolvency Figures.
•
The $120 million transfer.
Lenhart describes at pages 30-31 of his Report the wire transfer of $120 million derived from various Bayou entity accounts to an account in PostBank, Germany, in the name of Israel, the subsequent transfers of these funds among several accounts in Europe and the ultimate transfer of approximately $100 million back to the United States to a Wachovia bank account in New Jersey in the name of Majestic Capital Management, which funds were then seized by the State of Arizona and ultimately turned over to the United States Department of Justice. It appears that there is no explanation for the missing $20 million. The Report explains the reasons for Lenhart’s conclusion that no part of these funds should be included in the assets of the Bayou entities, including the FBI investigation and the fact that after the July 2004 transfer to PostBank there is no Bayou entity that records any part of these funds as a Bayou asset on any accounting or other document.
Despite the apparent misappropriation of this $120 million by Bayou Management, defendants argue based on certain documentary evidence that the $120 million or $100 million should be included as part of the Bayou assets for purposes of the solvency analysis. While the evidence would appear compelling that the $120 million transfer constituted a misappropriation by the Bayou principals, the issue is moot and need not be resolved. As reflected in the Fair Value Adjusted Balance Sheets at page 35 of the Lenhart Report, $100 million of the $120 million
was included
in the Bayou assets in the line item designated “Total Other Items for Consideration.” With this inclusion, the net deficit for 2004 was $95,893,019, and the net deficit for 2005 was $108,388,100 (referred to herein as the Minimum Insolvency Figures).
•
Valuation of illiquid private equity investments.
Defendants argue that Len-hart either undervalued or did not ascribe any value to certain private equity investments made by the Bayou hedge funds. The investments were illiquid because they consisted of unregistered securities. As noted by plaintiffs, the amounts of funds invested by the Bayou entities in these private equity investments amounted to some $14 million through July 2004, increased to approximately $20 million at the end of 2004 and increased to $34 million by July 2005. Defendants also take issue with certain earlier-acquired investments of the Bayou hedge funds, including investments in KFX, Nestor, Inc., Waste Systems International, Inc. and certain alleged “missed trades conducted by Patterson Securities throughout 2002.”
No purpose would be served by addressing the generalized contentions asserted by defendants in respect of these various assets. Suffice it to say that Lenhart has addressed in detail in his Report and Declaration every investment asset of the Bayou entities, including but not limited to those mentioned in defendants’ objections, and has comprehensively explained the treatment of those assets in the Lenhart Report and refuted all of defendants’ objections. In appropriate cases Lenhart has revalued certain assets and included the increased valuations in the line item “Total Other Items for Consideration” on the Fair Value Adjusted Balance Sheets, thereby reducing the net deficits to the Minimum Insolvency Figures. Despite the reductions in the deficits, the Minimum Insolvency Figures demonstrate that the Bayou hedge funds were nevertheless insolvent by substantial amounts throughout the Testing Period.
*841
•
Reliability.
The Lenhart Report is in essence no more nor less than a compilation and calculation of (i) the actual values of the Bayou entities’ assets, which were compared with the amount of the investors’ unredeemed principal invested to produce the actual deficits of Bayou, and (ii) the fraudulent NAVs reported by Bayou Management, which were correlated with the inflated amounts paid to the redeeming investors. As such, the Lenhart Report’s methodology is fundamentally unassailable — there is simply no other way to go about determining the facts than that described in the Lenhart Report.
In accomplishing their task, Lenhart and BDO examined all available source documents, including the books and records of all of the Bayou entities and all third-party source documents including bank account and brokerage account records for the Bayou entities, to determine the actual NAVs.
The applicable Federal Rule of Evidence for this task is Rule 1006, entitled “Summaries,” which provides:
The contents of voluminous writings, recordings, or photographs which cannot conveniently be examined in court may be presented in the form of a chart, summary, or calculation. The originals, or duplicates, shall be made available for examination or copying, or both, by other parties at reasonable time and place. The court may order that they be produced in court.
There can be no question that the compilations and summaries which comprise the Lenhart Report are appropriate and proper under Rule 1006, and plaintiffs complied with the second sentence of this Rule.
The volume of the source documents, the scope and breadth of the task, and the importance of the knowledge and experience of an expert such as Lenhart and the staffing and resources of his firm BDO certainly made it appropriate to retain Lenhart as an expert and present his conclusions in the form of an Expert Report, thereby invoking Federal Rule of Evidence 702, entitled “Testimony by Experts.” Rule 702 provides:
If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the ease.
There can be no question that the requirements of Rule 702 have been complied with.
(1) The Lenhart Report is not only “based upon sufficient facts or data,” it is based upon and comprehends all the available facts and data with respect to the assets of the Bayou entities and the tort liabilities of the Bayou hedge funds in respect of rescission claims for amounts invested by the investors.
(2) The Lenhart Report is “the product of reliable principles and methods” for determining the solvency of the Bayou hedge funds in accordance with the traditional, recognized methods for determining solvency, namely, the adjusted balance sheet test, the insufficient capital or assets test and the inability to pay debts as they become due test.
(3) Lephart “has applied the principles and methods reliably to the facts of the case.” In this case, reliability is assured by Lenhart’s identification of the source documents, complete and thorough explication of his
*842
methodology with full disclosure of all matters involving the exercise of professional judgment, and the fact that defendants have had ample opportunity to depose Lenhart, conduct their own examination of the source documents and investigation to identify other assets and grounds for objection.
At the end of the day, the fact is that the defendants have not identified a single asset of the Bayou hedge funds or, indeed, any of the Bayou entities, which has been overlooked by Lenhart. Nor have the defendants identified any mistakes or errors of calculation or omission in the Lenhart Report or the Exhibits thereto. With respect to defendants’ objections to Len-hart’s valuations of particular assets, Len-hart has fully and adequately explained in the Report and in the Declaration his reasons for the treatment of every single asset questioned by defendants. In the case of certain questioned assets, Lenhart has included the asset
(viz,
the $120 million wire transfer) and included revised values of other assets in the “Total Other Items for Consideration,” resulting in reduced deficits but nevertheless very substantial Minimum Insolvency Figures.
Although they have had ample opportunity to do so, the defendants have made no showing of any valid basis to object to the Minimum Insolvency Figures. Defendants’ objections to admissibility of the Lenhart Report are overruled.
C.
No triable issues of fact
In opposing summary judgment on plaintiffs’ actual and constructive fraudulent conveyance claims under Section 548(a), defendants have not tendered any evidence giving rise to any dispute of material fact requiring a trial. Indeed, defendants have not even argued that a trial is required to decide the Section 548(a) claims. At the oral argument on these motions for summary judgment, I pressed defense counsel to state whether there is need for a trial on the Section 548(a) claims and, if so, what evidence they would present. Counsel could identify no dispute and no evidence they would seek to present, other than a desire to cross-examine Lenhart on the matters covered by defendants’ objections to admissibility of the Lenhart Report. But Lenhart was examined by defense counsel at length at his deposition, and the transcript is available to all.
In short, plaintiffs’ actual and constructive fraudulent conveyance claims under Section 548(a) are ripe for determination on the record now before the Court.
D.
Ultimate findings and conclusions
1.
Actual fraud under Section 548(a)(1)(A)
Each redemption payment to defendants constituted a “transfer” within the meaning of Section 548(a). The only question is whether each such transfer was made “with actual intent to hinder, delay, or defraud” present or future creditors.
The guilty pleas and allocutions of Israel, Marquez and Marino establish that Bayou Management “made up numbers” and knowingly and intentionally caused to be published weekly, monthly, quarterly and annual reports containing falsely inflated earnings and NAVs for the Bayou hedge funds and individual investor accounts, with the intent and purpose of deceitfully inducing present investors to retain their accounts and prospective investors to invest.
Defendants’ contention that plaintiffs have not proved that each transfer was made with the requisite intent is refuted by the Lenhart Report and by common sense. The Lenhart Report has established on a month-by-month basis that the Bayou entities, and
a fortiori,
the Bayou
*843
hedge funds, were insolvent during the entire Testing Period from January 2002 through August 2005. Defendants have offered no evidence and no argument that any of the Bayou hedge funds was solvent at any time during the Testing Period. The Lenhart Report demonstrates that the periodic reports and individual investor account statements published by Bayou Management falsely represented inflated earnings, NAVs and investor account balances, including representations of fictitious profits despite the fact that the Bayou hedge funds did not earn profits. Finally, the Lenhart Report establishes that the redemption payments corresponded precisely to the fraudulently inflated account statements for the redeeming investors.
Since Israel and Marino confessedly knew that the investor account statements were inflated, why would they authorize redemption payments they knew exceeded the redeeming investors’ contractual entitlements, thereby exacerbating the insolvency and the damage to other investors? The answer is self-evident. It was essential to honor every request for redemption in accordance with the investor’s expectation based upon the investor’s falsely inflated account statement, because failure to do so would promptly have resulted in demand, investigation, the filing of a claim and disclosure of the fraud. Consequently, every redemption payment
in and of itself
constituted an intentional misrepresentation of fact with respect to the redeeming investor’s redemption rights based on the investor’s falsely inflated account statement. Redemption payments consistent with the fraudulent investor account statements were an integral and essential part of the Bayou fraud.
The conclusion is inescapable that corrupt Bayou Management authorized the fraudulently inflated redemption payments with “actual intent to hinder, delay, or defraud” because there cannot be any other explanation for Israel and Marino to authorize redemption payments in amounts to which they knew the redeeming investors were not contractually entitled and which deepened the insolvency and damaged the remaining investors.
I conclude that plaintiffs have established their
prima facie
case entitling plaintiffs to summary judgment against all defendants for the full amount of all redemption payments, subject to defendants’ affirmative defenses under Section 548(c). The affirmative defenses, which are addressed under point III, below, apply only to that portion of redemption payments constituting defendants’ capital investments and do not affect plaintiffs’ right to judgment under Section 548(a)(1)(A) with respect to fictitious profits.
2.
Constructive fraud under Section 548(a)(1)(B)
Plaintiffs have also established all the statutory elements entitling them to judgment against all defendants under Section 548(a)(1)(B) in respect of those portions of redemption payments limited to fictitious profits. As to each transfer of fictitious profits, each Bayou hedge fund “(i) received less than a reasonably'equivalent value in exchange for such transfer,” and each fund “(ii)(I) was insolvent on the date that such transfer was made.”
Redemption payments in respect of fictitious profits are not subject to the affirmative defense under Section 548(c), because the 548(c) defense applies only “to the extent that such transferee ... gave value to the debtor in exchange for such transfer.”
III.
Section 548(c) issues and conclusions
A.
The statute and case law
Once the plaintiffs have established their fraudulent conveyance claims
*844
under Section 548(a), the burden shifts to the defendants to allege and prove facts to establish their affirmative defense under Section 548(c).
The “value/good faith” affirmative defense to a fraudulent conveyance claim established under Section 548(a) is set forth in subsection (c). Section 548(c) provides as follows:
(c) ... [A] transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.
Under this provision, a transferee (redeeming Bayou investor) may retain the transfer (the redemption payment) if both of two conditions are met: (i) if the transferee “takes for value ...” but only “to the extent that such transferee ... gave value to the debtor in exchange for such transfer;” and (ii) if the transferee “takes ... in good faith.”
The “value” condition of the 548(c) defense is not in issue in these proceedings. That is because all of the defendants aver (as they must to establish the 548(c) defense) that they were entitled to the tort claim of rescission to recover 100% of the amount of their Bayou investments based upon the pervasive and continuing Bayou fraud which induced their investments in the Bayou hedge funds. For their part, plaintiffs do not (and cannot) contest the defendants’ rescission claims having alleged and proved (as shown above) the existence of the pervasive and continuing Bayou fraud in order to establish their fraudulent conveyance claims under Section 548(a).
The “good faith” condition of the 548(c) defense is hotly contested as a matter of fact, although not as a matter of law. The Bankruptcy Code does not define “good faith.” Thus, to determine what it means to say that a transferee “takes [a redemption payment] in good faith” one must look to the case law.
There is no real dispute between the plaintiffs and defendants as to the relevant case law construing the “good faith” defense under Section 548(c), nor are there materially conflicting views expressed in the reported decisions. It will be useful to quote in full the case law summary set forth at pages 46-51 of plaintiffs’ Omnibus Memorandum because it reflects plaintiffs’ view of the law to which none of the defendants has taken material exception.
The Bankruptcy Code does not define “good faith” as used in section 548(c).
Jobin v. McKay (In re M & L Bus. Machine Co., Inc.),
84 F.3d 1330 , 1335 (10th Cir.1996);
Holber v. Dolchin Slotkin & Todd, P.C. (In re Am. Rehab & Physical Therapy, Inc.),
2006 WL 1997431 , at * 19 (Bankr.E.D.Pa. May 18, 2006). Moreover, “the legislative history related to section 548(c) never defines, and scarcely addresses, good faith.”
Id.
at * 19 n. 21. (quotation marks and citation omitted).
Nevertheless, federal courts have reached a consensus that “good faith” as used in section 548(c) must be determined according to an “objective” or “reasonable person” standard, and not on the subjective knowledge or belief of the transferee.
In re Manhattan Inv. Fund,
2007 WL 4440360, at * 17 ;
Enron Corp. v. Avenue Special Situations Fund II, L.P. (In re Enron Corp.),
340 B.R. 180, 207 (Bankr.S.D.N.Y.2006),
rev’d on other grounds,
379 B.R. 425 , 2007 WL 2446498 (S.D.N.Y. Aug.27, 2007);
see also Warfield v. Byron,
436 F.3d 551, 559-60 (5th Cir.2006) (analyzing analogous provision under Uniform
*845
Fraudulent Transfer Act);
Jobin v. McKay,
84 F.3d at 1337-38 (10th Cir.1996);
Brown v. Third Nat’l Bank (In re Sherman),
67 F.3d 1348 , 1355 (8th Cir.1995);
In re Agric. Research and Tech. Group, Inc.,
916 F.2d at 535-36 (recognizing that UFTA provision is interpreted same as § 548(c));
Terry v. June,
432 F.Supp.2d 635, 641 (W.D.Va.2006) (analyzing analogous provision under UFTA).
Under this objective standard, “subjective assertions of good faith ... are of no moment.”
In re Agric. Research and Tech. Group,
916 F.2d at 536. Instead, “courts look to what the transferee objectively ‘knew or should have known’ in questions of good faith, rather than examining what the transferee actually knew from a subjective standpoint.”
Id.
at 535-536;
see also In re Enron Corp.,
340 B.R. at 208 n. 25 (same).
Accordingly, a transferee cannot be found to have taken a transfer in good faith “if the circumstances would place a reasonable person on inquiry of a debt- or’s fraudulent purpose, and a
diligent
inquiry would have discovered the fraudulent purpose.”
Jobin v. McKay,
84 F.3d at 1338 (quoting
In re Agric. Research and Tech. Group, Inc.,
916 F.2d at 536) (internal citations omitted) (emphasis in original);
see also Banner v. Kassow,
104 F.3d 352 , 1996 WL 680760, at *3 (2d Cir. Nov.22, 1996) (“transferee does not act in good faith when he has sufficient knowledge to place him on inquiry notice of the debtor’s possible solvency [sic — should read ‘insolvency’]”);
Terry v. June,
432 F.Supp.2d at 641 (“the transferee must show not that he was subjectively unaware of the trans-feror’s fraudulent intent, but rather that he did not have knowledge of facts that should have reasonably put him on notice that the transfer was made in order to delay, hinder, or defraud creditors of the debtor”).
In an opinion published just last month, District Judge Buchwald confirmed the law in this District that statutory “good faith” requires either that: (1) the transferee was not on “inquiry notice” or (2) if on notice, the transferee was “diligent in its investigation” of the transferor.
In re Manhattan Inv. Fund Ltd.,
2007 WL 4440360, at * 17 . As Judge Buchwald made clear, a transferee may be on “inquiry notice” without actual knowledge of a fraud or other circumstance.
Id.
at * 17. Rather, a transferee is on “inquiry notice” if it knew or should have known of information placing it objectively
“on alert that there was a potential problem with the Fund
” such that the transferee “should have attempted to learn more.”
Id.
at *17 (emphasis added). As Judge Buchwald recognized, the “support for a finding of inquiry notice is found in [the transferee’s] own reaction” to the information it learned.
Id.
at * 17. Whether a transferee was on “inquiry notice” may also be informed by,
inter alia,
the experience or sophistication of the transferee.
Jobin v. McKay,
84 F.3d at 1338.
Courts have held that “inquiry notice” of a variety of circumstances precludes a finding of good faith, including “inquiry notice” of the:
•
Fraudulent purpose of the transfer. In re Agric. Research and Tech. Group, Inc.,
916 F.2d at 535;
Terry v. June,
432 F.Supp.2d at 641 .
•
Underlying fraud. In re Manhattan Inv. Fund,
2007 WL 4440360, at * 17 ;
Cuthill v. Kime (In re Evergreen Sec., Ltd.),
319 B.R. 245, 255 (Bankr.M.D.Fla.2003) (“Circumstances putting the transferee on inquiry notice as to ... an underlying fraud ... will preclude a transferee from asserting a good faith defense.”).
*846
•
Unfavorable financial condition of the transferor. Jobin v. McKay,
84 F.3d at 1335-36 (“the presence of any circumstance placing the transferee on inquiry as to the financial condition of the transferor may be a contributing factor in depriving the former of any claim to good faith unless investigation actually disclosed no reason to suspect financial embarrassment”) (quotation marks and citation omitted);
In re Enron Corp.,
340 B.R. at 207 (transferee does not act in good faith if it knew or should have known of “unfavorable financial condition at the time of the transfer”).
•
Insolvency of the transferor. In re Sherman,
67 F.3d at 1355 ;
Kassow,
104 F.3d 352 , 1996 WL 680760, at *3 .
• Improper nature of a transaction. In re Evergreen Sec., Ltd.,
319 B.R. at 255 (Bankr.M.D.Fla.2003) (“Circumstances putting the transferee on inquiry notice as to ... the improper nature of a transaction will preclude a transferee from asserting a good faith defense.”).
•
Voidability of the transfer. In re Am. Rehab & Physical Therapy, Inc.,
2006 WL 1997431 , at * 19 (“a transferee does not act in good faith when it has sufficient knowledge to place it on inquiry notice of the voidability of the transfer”).
These enumerated circumstances, however, are not exhaustive and thus “good faith” must be evaluated on a case-by-case basis.
In re Sherman,
67 F.3d at 1355 ;
Jobin v. McKay,
84 F.3d at 1335 (“courts applying § 548(c) have generally refused to formulate precise definitions” of good faith);
In re Agric. Research and Tech. Group, Inc.,
916 F.2d at 536 (“good faith is not susceptible of precise definition”) (internal quotation marks and citations omitted);
Stevenson v. J.C. Bradford & Co. (In re Cannon),
230 B.R. 546, 592 (Bankr.W.D.Tenn.1999) (“Courts have found good faith lacking in a wide variety of circumstances.”),
amended in part by,
232 B.R. 701 (Bankr.W.D.Tenn.1999),
rev’d on other grounds,
2000 WL 346400479 (W.D.Tenn. Mar.31, 2000); 5
Collier on Bankruptcy
548.07[2][a] at 548-60 (15th ed. 2007) (“The unpredictable circumstances in which the courts may find its presence or absence render any definition of ‘good faith’ inadequate, if not unwise.”).
Once on inquiry notice, a transferee’s failure to conduct a “diligent investigation” is fatal to its “good faith” defense. In order to prove “good faith,” that “diligent investigation” must ameliorate the issues that placed the transferee on inquiry notice in the first place.
Jobin v. McKay,
84 F.3d at 1335-36 (“the presence of any circumstance placing the transferee on inquiry as to the financial condition of the transferor may be a contributing factor in depriving the former of any claim to good faith
unless investigation actually disclosed no reason to suspect financial embarrassment”)
(quotation marks and citation omitted) (emphasis added). In other words, if the diligent investigation aggravates, rather than allays, the concerns placing the transferee on inquiry notice, then no “good faith” defense is supported.
Moreover, a transferee cannot satisfy the “diligent investigation” prong of the “good faith” test merely by inquiring with the transferor itself, even were the transferor to provide a plausible explanation of the issues. As Bankruptcy Judge Lifland observed in his
In re Manhattan Investment Fund
decision, and Judge Buchwald agreed in her decision, a “diligent investigation” requires more than merely asking the transferor about the suspicious circumstances.
See Gredd v. Bear, Stearns Secs. Corp. (In
*847
re Manhattan Inv. Fund),
359 B.R. 510, 526 (Bankr.S.D.N.Y.2007) (for diligent investigation, transferee is “required to do more than simply ask the wrongdoer if he was doing wrong”),
aff'd in part & rev’d in part, In re Manhattan Inv. Fund,
2007 WL 4440360, at * 19 (diligent investigation had to include something more than just speaking to hedge fund’s principal, even where the principal’s explanation of suspicious circumstances was “not only facially plausible, but also comforting”).
In other words, a transferee cannot put his head in the sand in the face of unusual or suspicious circumstances and then take advantage of the “good faith” defense afforded by section 548(c). As Judge Buchwald noted in
In re Manhattan Inv. Fund,
once on inquiry notice, “taking no steps at all would have amounted to ‘willful ignorance,’ which would have defeated the good faith defense.” 2007 WL 4440360 , at * 19 n. 39;
see also Development Specialists, Inc. v. Hamilton Bank, N.A. (In re Model Imperial, Inc.),
250 B.R. 776, 798 (Bankr.S.D.Fla.2000) (“The mere failure to make inquiry in the face of unusual circumstances [ ] is sufficient to preclude a good faith defense.”);
In re Cannon,
230 B.R. at 592 (“courts have found mere failure to inquire in the face of unusual circumstances to be sufficient” to find lack of good faith);
see also HBE Leasing Corp. v. Frank,
48 F.3d 623, 636 (2d Cir.1995) (under New York state law equivalent to section 548(c), “[c]onstructive knowledge of fraudulent schemes will be attributed to transferees who were aware of circumstances that should have led them to inquire further into the circumstances of the transaction,
but who failed to make such inquiry
”) (emphasis added).
Plaintiffs’ Omnibus Memorandum of Law at 46-51; emphasis as in the Omnibus Memorandum.
I agree with plaintiffs’ exposition of the case law and have endeavored to apply the precedents as relevant to the disparate facts in these adversary proceedings. The parties’ dispute lies in the application of the case law to the particular facts for each defendant or group of defendants. Before turning to the facts, however, it is important to set forth this Court’s views on certain aspects of the law which have informed my conclusions as to each defendant, since my views may be thought to differ in some respects from the case law
{e.g.,
the “objective/subjective” dichotomy discussed below).
It should be noted first that the concept of “good faith” embodied in Section 548(c) is somewhat different from the traditional notion of good faith as the term is customarily used by laymen. In common parlance, the term “good faith,” as distinguished from its counterpart “bad faith,” denotes a conformity with accepted standards of integrity, trust and good conduct and the absence of any of the usual indicia of bad faith such as dishonesty, deceit, intent to harm or complicity in some form of wrongdoing.
7
Consequently, to say that a person has
not
acted in “good faith,” or in context here, that the person has not proved his defense of “good faith,” might be thought to imply that the person’s action in question was wrongful, improper or legally or ethically deplorable in some manner.
8
But the narrow, layman’s definition is not the meaning ascribed to Section
*848
548(c) “good faith” by the case law, which looks to the broader meaning expressed in Black’s Law Dictionary, quoted in footnote 8. Where the rule of law holds that an investor may not be able to establish his statutory good faith defense because he requested redemption of his investment after becoming aware of a “red flag” putting him on “inquiry notice” of possible infirmity in his investment, that does not necessarily entail a finding or carry an imputation that he was guilty of any sort of
mala fides
or otherwise deserving of opprobrium. To the contrary, any rational investor or financial advisor, on inquiry notice of a warning signal respecting an investment, would be entirely justified in requesting or recommending redemption and could not be criticized for doing so. Indeed, it would be quite reasonable for an investor to decide to redeem solely on the basis of the red flag without making any inquiry, since the investor has no obligation to any third party to make any inquiry. But if he does so, the courts have held that he cannot invoke the good faith defense under Section 548(c).
Thus, it is important for the trier of fact to understand that the test for good faith under Section 548(c) is not whether the defendant was guilty of any sort of bad faith in requesting and receiving the transfer. The test is whether the defendant requested redemption after learning of a “red flag” which, under an “objective” standard, should have put the defendant on “inquiry notice” of some infirmity in Bayou or the integrity of its management. The rule does not require that the “red flag” be of such specificity as to put the recipient on “inquiry notice” of the actual fraud, or embezzlement, or looting, or whatever ultimately proves to be the cause of loss. It is sufficient if the red flag puts the investor on notice of some potential infirmity in the investment such that a reasonable investor would recognize the need to conduct some investigation.
The “diligent investigation” is required not because of any duty to inquire owed to a third party. It is required only to prove the plausibility of the defendant’s asserted good faith reason for redemption independent of the red flag, notwithstanding his knowledge of the red flag, by showing that the facts learned upon inquiry reasonably allayed any concern raised by the red flag.
The “objective” versus “subjective” dichotomy under the case law holds that “subjective assertions of good faith ... are of no moment” and that “courts look to what the transferee objectively ‘knew or should have known’ in questions of good faith, rather than examining what the transferee actually knew from a subjective standpoint.”
In re Agric. Research and Tech. Group, Inc.,
916 F.2d 528, 535-536 . But what if a defendant on inquiry notice because of red flags goes ahead and redeems without conducting an inquiry which reasonably allays the concern raised by the red flag — does the objective test mean that a defendant’s actual, subjective intent, purpose or state of mind is never relevant? Stated differently, is a defendant barred as a matter of law from proving his actual good faith purpose in requesting redemption
(ie.,
a purpose independent of and not motivated by a red flag warning signal) once it is shown that he had knowledge of “red flags” which would put the objective “reasonable man” on inquiry notice? I would answer “no” to these questions, but only in the following limited circumstance. Recognizing that the burden is on the defendant to prove his 548(c) defense, I
*849
would hold that a defendant may establish his defense if he can prove by a preponderance of the credible
objective evidence
that his request for redemption was in fact the result of a good faith reason other than his knowledge of “red flags,” even if he was on inquiry notice and did not make inquiry before redeeming. By “objective evidence” I mean independent evidence of facts, as opposed to mere “subjective assertions of good faith” by the defendant himself or the testimony of others that cannot be objectively verified. An example of such limited circumstances may be seen in the
DB Structured Products
adversary proceeding discussed at Point III C 1, below, where it was perfectly clear that the investor redeemed for an objectively identifiable reason having nothing to do with any red flag warning.
9
Therefore, while I maintain that an objective standard must be applied to the good faith analysis, to disregard objective evidence of the transferee’s subjective good faith intent would fundamentally distort the concept of good faith.
See, e.g., Moglia v. Universal Auto., Inc. (In re First Nat’l Parts Exch., Inc.),
2000 WL 988177 , **6-8, 2000 U.S. Dist. LEXIS 10420 at *19-25 (N.D.Ill. July 12, 2000) (finding that a good faith analysis should weigh both subjective good faith and the objective basis for that good faith).
Another issue raised by plaintiffs in respect of certain defendants here is whether knowledge of red flags acquired after a request for redemption undermines the defendant’s good faith defense which was valid as of the date of the request. Plaintiffs have argued that the statutory language “takes ... in good faith” requires that good faith be determined as of the date the redemption payment is actually received. It may perhaps be that on other facts in other contexts the issue of good faith could or should be determined as of the date the transfer is actually received. But not here. Under the Bayou investor agreements a written request for redemption is effective at the end of the month when made. Although the redemption payment need not be made for an extendable period of time after the written request, the redeeming investor does not remain invested and subject to gains and losses in the fund after the month of the request to redeem. If a defendant can prove that his request for redemption was not motivated by knowledge of a red flag portending infirmity within Bayou, that defense is not undermined by delays in payment or other post-request red flags.
A number of defendants have advanced what may be called the “futility argument,” asserting that inquiry after notice of a red flag would have been futile because no amount of diligent investigation would have uncovered the Bayou fraud, citing the fact that the fraud was not discovered by the regulators, investment professionals or investors for years, and that the District Court, in dismissing a Bayou investor’s Section 10(b) Securities Exchange Act claim against its investment advisor, stated that “[o]ne substantial competing inference this Court may draw from these alleged facts is that due diligence would not have uncovered the fraud.”
South Cherry Street LLC v. Hennessee Group LLC, et al. (In re Bayou Hedge Fund Litigation),
534 F.Supp.2d 405, 418 (S.D.N.Y.2007).
10
In the context of this
*850
case and the “good faith” defense under Section 548(c) of the Bankruptcy Code, defendants’ “futility argument” must be rejected as a matter of fact and law.
In point of fact, defendants’ argument that the Bayou fraud was impossible to detect obviously is wrong. As amplified in the facts sections below, simple diligence in the form of questions put to Israel and Marino with insistence on documented answers and access to source documents supporting the Bayou hedge funds’ net asset values (“NAVs”) and inquiry directed to Bayou’s purported independent auditor would have and, in fact, did reveal that Richmond-Fairfield Associates was not an independent accounting firm, that Marino was the principal of Richmond-Fairfield, and that the Bayou principals alone determined the NAVs of the Bayou hedge funds without any independent review and verification. Even Bayou insiders were denied access to the Bayou books and records necessary to determine the NAVs,
11
and any request by an investor to have his own accountants examine the Bayou books and records had to be, and was, refused.
12
That refusal, and the fact that Richmond-Fairfield was not an independent accounting firm as falsely represented, perhaps did not reveal the scope and details of the fraud, but those readily ascertainable facts alone made quite apparent that there was misrepresentation in the published finan-cials and some serious defect in the financial affairs of the Bayou hedge funds that could not withstand scrutiny. Any person with access to the prime broker statements and the incentive and ability to compare the source documents with the false financial statements published by corrupt management would have discovered the fraud.
Defendants’ “futility argument” must also fail as a matter of law if it is offered somehow to support a good faith defense.
13
The rule of law formulated by the courts interpreting Section 548(c) does not turn upon whether the investor-defendant could or should, or did or did not, actually discover the fraud. If a defendant had actual knowledge of the fraud, of course this would defeat good faith. If he did not have actual knowledge but received one or more “red flags” putting him on “inquiry notice” of possible problems with his Bayou investment, then, to prove his good faith, defendant had to conduct a diligent inquiry reasonable under the circumstances. If a defendant could show that the response to his inquiry was sufficient to allay his concerns and could persuade the trier of fact that his subsequent decision to redeem his Bayou investment was motivated by some good faith reason other than the red flags prompting his notice inquiry, such a defendant would presumably have sustained his burden of establishing his good faith defense. But to suggest that the good faith defense can be established, or that there was no duty to
*851
make diligent inquiry, simply by arguing that discovery of the fraud was impossible does not comport with the rule of law established by the decisions.
One of the defendants who redeemed on the advice of their investment advisor CSG (point III E 3, below) argued that CSG conducted a diligent investigation on its behalf and did not discover the fraud, and that this fact without more establishes the defendant’s good faith affirmative defense under Section 548(c). The argument, which we may label for easy reference the “inconclusive diligent investigation” argument, is as follows:
The Plaintiff suggests throughout its Omnibus Memorandum of Law that a diligent investigation that does not discover fraud is nevertheless insufficient to invoke 548(c) if the investigation does not “allow” [sic — should read “allay”] or “ameliorate” any suspicions the defendant may have.
See, e.g.,
Plaintiffs Memorandum of Law, pp. 49-50.
The case law does not so hold. The standard as articulated by the courts is that a transferee does not take in good faith under 548(c) if a diligent investigation would have discovered fraud.
Christian Brothers High School Endowment’s Memorandum of Law at 40. In its Reply Memorandum, the High School Endowment amplifies the position, arguing as follows:
As long as a transferee’s diligent investigation does not uncover the transferor’s actual fraud, a transferee’s lingering concerns or suspicions will not vitiate its “good faith,” nor is perfection required for an investigation to be diligent.
... It would be an almost impossible standard to meet as a defense to recovery of an actually fraudulent conveyance to require a transferee to be both (a) diligent in its investigation of what is in fact a fraud (indeed, because “good faith” is an affirmative defense, in every case under 548(a)(1)(A) in which the outcome turns on whether the transferee took in “good faith,” the transferor by definition engaged in actual fraud) AND (b) have no lingering concerns or suspicions regarding the transferor and the transfer (as opposed to actually uncovering the fraud). That is, it would virtually rescind the availability of the “good faith” defense to expect a transferee to conduct an investigation that is diligent but that at the same time leaves the transferee with no concerns or suspicions.
Christian Brothers High School Endowment’s Reply Memorandum at 9.
The “inconclusive diligent investigation” argument misunderstands both the good faith defense and the purpose for the “diligent investigation” and misstates the case law. It bears repeating that Section 548(c) provides for an affirmative defense, and the burden is on the defendant to prove that defense. In these adversary proceedings each defendant redeeming investor must prove that he took the redemption payment “in good faith,”
i.e.,
he demanded to take his investment out of the particular Bayou fund not because he had some information that there was some infirmity in the fund, but because of some other reason personal to him and extraneous to the well-being of the fund and its remaining investors. The case law holds that the redeeming investor cannot sustain his burden to prove his good faith if the evidence shows that he was on objective notice of some infirmity in the fund. If he was on such inquiry notice, he may nevertheless overcome the logical presumption that he redeemed because of the red flag by proving that he conducted a diligent investigation which, judged under a “reasonable
*852
man” standard, allayed or set to rest the concerns aroused by the red flag, thereby establishing the
bonafides
of his proffered extraneous good faith reason for redeeming.
What the cases do not hold is that the defendant’s good faith defense is established if the investigation is not carried on to the point that it proves that there was a fraud. As a practical matter, few if any “inquiry notice” investigations will be carried on to the point of actually proving fraud. Once the investigation encounters evasion or stonewalling exacerbating the concerns caused by the original red flag, the sensible investor will promptly redeem without spending more time and money on further inquiry.
14
The “inconclusive diligent investigation” argument must be rejected because it is precisely the purpose and the effect of the objective approach adopted by all the courts in interpreting Section 548(c) to “virtually rescind the availability of the ‘good faith’ defense [where the transferee or its surrogate] conduces] an investigation that is diligent but that at the same time leaves the transferee with [ ] concerns or suspicions.” This is especially so in a case where a defendant, such as the Christian Brothers High School Endowment, asserts no extraneous reason at all for its decision to redeem other than the CSG investigation and the reasons for CSG’s recommendation to its clients to redeem.
See
point III E 5(b), below, concerning the Christian Brothers High School Endowment.
As shown in point III E 3, below, the concerns that motivated CSG to investigate Bayou as agent for its clients (the
Westervelt
complaint and the need to verify net asset values) were not set to rest by the June 22 meeting, they were compounded. CSG representatives did not actually uncover the Bayou fraud at the June 22 meeting, although there can be little doubt that they could and would have discovered the fraud if, like Altegris (points III E 1, below), they had pressed their inquiry to the next logical step of insisting on interviewing the Active Richmond-Fairfleld, which was fraudulently represented to be the “independent auditor” of the Bayou hedge funds. But what CSG did learn was that there was some reason why Bayou management could not or would not provide the “transparency” which the investors were contractually entitled to receive and Bayou was required to give. CSG concluded, quite understandably, that Marino’s stonewalling at the June 22 meeting destroyed their trust in Bayou and mandated their decision to redeem without the need for further investigation. Any argument that such facts establish a CSG’s client’s statutory good faith under Section 548(c) must be rejected as a matter of fact and law.
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B.
Background: good faith defenses accepted by plaintiffs
1.
Proceedings not settled
John Barr III IRA and John Barr III (Adv.Proc. No. 07-08244) Myrna Bennett (Adv.Proc. No. 06-08420)
Madison Capital Advisors Ltd. (Adv.Proc. No. 06-08403)
After conducting discovery, plaintiffs agreed that the defendants in these three adversary proceedings had established their Section 548(c) good faith defenses by objective evidence and, accordingly, plaintiffs have relinquished their claims against these defendants to recover redemption payments of principal invested. These adversary proceedings remain contested in respect of plaintiffs’ claims to recover redemption payments of fictitious profits. In accordance with this Court’s rulings under points II D 1 and 2, above, plaintiffs are entitled to judgment against these defendants in respect of their redemption payments limited to fictitious profits.
2.
Proceedings settled
After conducting discovery, plaintiffs settled, with Court approval, forty-five adversary proceedings and two other potential claims against redeeming Bayou investors based on acceptance of defendants’ Section 548(c) good faith defenses. The settlement agreements required the settling defendants to repay to the plaintiffs the full amounts of fictitious profits received on redemption, but permitted them to retain the full amounts of redemption payments of principal invested.
The following is a representative sample of such settlements illustrative of good faith defenses under Section 548(c) established by objective evidence and not contested by the plaintiffs.
1. UT Medical Group Pension Plan (Adv.Proc. No. 06-08292) On advice of independent auditors and counsel, the Plan liquidated its Bayou investment and similar investments to comply with ERISA and the Plan’s Trust Agreement.
2. Singer 1995 Family Trust (Adv.Proc. No. 06-08871) The Trust requested redemption for the sole purpose of funding the purchase of a home by the Trust’s beneficiary.
3. Daisy Family Limited Partnership (Adv.Proc. No. 06-08397) The Partnership was managed by Charles Lieb until his death in 2005. Redemption was requested as part of liquidation of assets for transition of investment management and administrative matters in anticipation of Lieb’s death.
4. Steven R. Selcer (Adv.Proc. No. 06-08401) Redemption was requested to fund expenses of a newborn child and private school tuition expenses of an older child.
5. Keith Arroyo (Adv.Proc. No. 06-08425) Arroyo requested only partial redemption of his Bayou investment. The balance of the investment was returned to Arroyo and his account was closed by Bayou for falling below the minimum investment balance requested by Bayou.
6. Trail Ridge Flatiron Fund, L.P. (Adv.Proc. No. 07-08247) Trail Ridge, a fund of funds, made a partial redemption of its Bayou investment to satisfy redemption requests from its investors, to make payment on its loan from a bank and to reduce the size of its position in the Bayou fund.
7. David and' Ann Fristoe (Adv.Proc. No. 08-08228) The Fristoes requested redemption in order to obtain funds to purchase a new home.
8. LeBlanc Enterprises, Ltd. (Adv. Proc. No. 08-08246) LeBlanc’s mon
*854
ey managers moved from Oppenheimer to UBS and advised LeBlanc that Bayou did not fit the UBS profile and thus was not part of the UBS investment platform.
C.
Good faith defenses sustained
For the reasons stated below, I have concluded that cross-motions for summary judgment for dismissal of plaintiffs’ claims to recover redemption payments of principal invested should be granted in the following three adversary proceedings based upon the defendants’ good faith defenses asserted under Section 548(c). This does not affect plaintiffs’ right to judgment against these defendants to recover any redemption payments in respect of fictitious profits in accordance with this Court’s rulings under point II D 1 and 2, above.
1.
DB Structured Products, Inc. (Adv.Proc. No. 06-08494)
The material facts are not in dispute and, while somewhat complex, may be concisely summarized. The ultimate parent corporation of DB Structured Products, Inc. (together with its predecessor in interest, “DBSP”) was Deutsche Bank A.G. (“Deutsche Bank”). At the instruction of Deutsche Bank, DBSP made two separate and independent investments in a Bayou hedge fund in connection with two separate swap transactions entered into by Deutsche Bank.
In January 2002 Deutsche Bank entered into a swap transaction (the “Alerion Swap”) with the predecessor-in-interest to Alerion Strategies Holdings, Ltd. (“Aler-ion”) wherein Alerion would be exposed to the performance of various hedge funds including a predecessor of one of the Bayou hedge funds. Pursuant to the Alerion Swap, Deutsche Bank agreed to pay Aler-ion any increase that a hypothetical investor would receive on an investment in the Bayou hedge fund, and Alerion agreed to pay Deutsche Bank any loss that such a hypothetical investor would incur. The terms of the Alerion Swap did not require Deutsche Bank to make a direct investment in the Bayou hedge fund in question, but because Deutsche Bank did not wish to take investment risk related to its customer’s swap transactions, it elected to hedge its risk in the Alerion Swap with a direct investment by its affiliated company, DBSP, in the various hedge funds underlying the swap, including the particular Bayou hedge fund. Thus, in connection with the Alerion Swap as it was modified and increased from time to time, DBSP had directly invested a total of $16,240,000 in a Bayou hedge fund as a hedge to its risk under the Alerion Swap by the time of the Bayou collapse in August 2005. Because the Alerion Swap was still outstanding as of August 2005, DBSP never requested redemption of its investment in the Bayou hedge fund.
By agreements dated in July 2003 and thereafter Deutsche Bank entered into a separate swap transaction (the “Total Return Swap”) with a predecessor-in-interest to Sterling Stamos Levered (Offshore) Fund, Ltd. (“Sterling Levered”). Sterling Levered, not Deutsche Bank or DBSP, determined what funds Sterling Levered wished to be exposed to in the Total Return Swap. Through the Total Return Swap, Sterling Levered obtained from Deutsche Bank synthetic exposure to the performance of Bayou Superfund and several other non-Bayou funds. Deutsche Bank was required to pay Sterling Levered for any appreciation in the notional value of a hypothetical investment in Bayou Superfund, and Sterling Levered was required to pay Deutsche Bank for any depreciation in the notional value of such investment during the term of the Total Return Swap. Although Deutsche Bank was under no obligation to hedge its risk associated with the Total Return
*855
Swap, it directed DBSP to make a direct investment in Bayou Superfund as a hedge against Deutsche Bank’s Total Return Swap exposure. Over time, as Sterling Levered increased its synthetic exposure to Bayou Superfund, DBSP increased its long hedge position in Bayou Superfund as a hedge against Deutsche Bank’s increased exposure under the Total Return Swap. On February 11, 2005 Peter Stamos notified Deutsche Bank of Sterling Levered’s decision to terminate the Total Return Swap with respect to Bayou Superfund effective as of February 28, 2005. At that time, DBSP’s total investment in Bayou Super-fund was $16,500,000. No longer, needing the hedge against the Total Return Swap, DBSP sent a letter dated February 11, 2005 to Bayou Superfund requesting redemption of its $16,500,000 investment.
It is perfectly evident from the foregoing undisputed facts that DBSP made its investments in Bayou hedge funds aggregating more than $32 million solely as a hedge against Deutsche Bank’s exposure to risk under the Alerion Swap and the Total Return Swap, and that DBSP requested redemption of its Bayou Super-fund investment because Deutsche Bank’s risk exposure was terminated under the Total Return Swap, while it did not request redemption of its Bayou hedge fund investment in respect of the Alerion Swap because the Alerion Swap was not terminated. These facts would establish DBSP’s good faith defense even if Deutsche Bank or DBSP had received knowledge of “red flags” putting them on inquiry notice with respect to the Bayou hedge funds, but DBSP denies that it had any knowledge of red flags respecting Bayou and plaintiffs do not claim that it had any such knowledge.
Plaintiffs’ argument is, in substance, that Sterling Stamos controlled the decision whether the Total Return Swap should continue to cover Bayou Superfund or should be terminated with respect to the Bayou investment, and that DBSP and Deutsche Bank were fully protected from any loss in respect of the Total Return Swap by reason of the Bayou long position hedge held by DBSP and Sterling Stamos’ secured obligation to indemnify Deutsche Bank in the event of loss. The argument may be factually true, but compels the opposite conclusion. It demonstrates that DBSP’s reason for requesting redemption was not any knowledge of red flags putting it on inquiry notice, but simply the fact that Sterling Stamos terminated the Total Return Swap with respect to Bayou, rendering unnecessary DBSP’s long position hedge in Bayou Superfund. The fact (if it is a fact) that Sterling Stamos would be obligated to indemnify DBSP if DBSP were required to refund its redemption payment in respect of the amount it invested in Bayou Superfund is not relevant here, because DBSP has established its good faith defense under Section 548(c) precluding liability in respect of the redemption of the amount it invested in Bayou Superfund.
Plaintiffs argue in reply that:
Deutsche Bank, through its affiliate DBSP, bore no financial risk from DBSP’s investment in Bayou Superfund because the investment exactly mirrored and hedged Sterling Stamos’s synthetic exposure under the Total Return Swap.
Plaintiffs’ Omnibus Reply Memorandum at 78. The argument continues:
DBSP redeemed its Bayou Superfund investment automatically as a result of Sterling Stamos’s decision to terminate its synthetic exposure to Bayou Super-fund under the Total Return Swap. As a matter of institutional policy, Deutsche Bank, through its affiliates such as DBSP, always redeemed hedge fund in
*856
vestments when its counterparty terminated a swap transaction.
Id.
at 78-79. The argument concludes:
In sum, DBSP, as a matter of law, cannot sustain a “good faith” defense under section 548(c) of the Bankruptcy Code because its Bayou Superfund investment was intentionally structured such that DBSP’s redemption decision was necessarily triggered by Sterling Stamos’s decision to terminate the Total Return Swap, and DBSP “put on blinders” to Sterling Stamos’s knowledge regarding the Bayou hedge funds.
Id.
at 79.
Contrary to the plaintiffs’ legal conclusion, the facts relied upon by plaintiffs conclusively establish DBSP’s good faith defense as a matter of law. These facts demonstrate that, even if DBSP representatives had knowledge of the red flags which allegedly put Sterling Stamos on inquiry notice (which plaintiffs do not assert), the DBSP decision to redeem its Bayou Superfund hedge position was motivated not by any red flag or anxiety respecting Bayou but solely because the Bayou investment was no longer required as a hedge against Deutsche Bank’s risk under the Total Return Swap.
Plaintiffs’ concluding assertion that “DBSP ‘put on blinders’ to Sterling Sta-mos’s knowledge regarding the Bayou hedge funds”
(id.)
appears to suggest that Sterling Stamos’ alleged knowledge and inquiry notice should be attributed to DBSP, a contention (if it is plaintiffs’ contention) that is frivolous as a matter of fact and law. Sterling Stamos was not DBSP’s or Deutsche Bank’s broker or agent or investment advisor whose knowledge or purpose could be attributed to either — it was Deutsche Bank’s counterparty in arm’s length swap transactions.
The undisputed facts establish DBSP’s good faith defense under Section 548(c) and require dismissal of plaintiffs’ claim against DBSP in respect of the amount DBSP invested in Bayou Superfund.
2.
High Sierra Investments (Adv. Proc. No. 07-08243)
High Sierra Investments (“High Sierra”) was a hedge fund which invested in other hedge funds (fund of funds). High Sierra made an initial investment of $5 million in Bayou Superfund in November 2003 and an additional investment of $5 million in Bayou Superfund in November 2004, for a total of $10 million invested. To quote plaintiffs:
At some point in late 2004 or early 2005, High Sierra learned that its largest investor — [“Redacted Investor”]' — anticipated making a large redemption from High Sierra.... High Sierra thus needed to raise money to satisfy that redemption, which High Sierra expected to be effective at the end of March 2005.... Accordingly, High Sierra initially sought full redemptions — all to be effective at the end of March 2005— from three of its investments: Bayou Superfund [and two other funds].... At the time, High Sierra’s Bayou Superfund investment was reportedly worth approximately $11 million.
Plaintiffs’ Omnibus Memorandum of Law at 205.
On or about February 17, 2005 High Sierra sent a complete redemption notice to Bayou Superfund. After learning that its Redacted Investor’s actual redemption request was lower than expected, on March 2, 2005 High Sierra rescinded its full redemption request from Bayou Su-perfund and instead submitted a partial redemption request in the amount of $9.8 million, advising that High Sierra was “very happy to be able to preserve [the Bayou] investment” and “look[ed] forward to a LONG standing relationship with Bayou.”
Id.
The redemption was “to be
*857
effective at the end of March 2005.”
Id.
Section 10.4 of the Bayou Accredited Fund’s Operating Agreement provided that payment of redemptions up to ninety percent of an investor’s account “shall be made ... within thirty (30) days of the effective date of the withdrawal.” Under this provision, High Sierra would have expected payment in full of its $9.8 million request for redemption by the end of April 2005. However, as acknowledged by plaintiffs (Omnibus Reply Memorandum at 81), the Operating Agreement reserved the right for Bayou Superfund to extend the payment deadline for an additional ninety days if “in the opinion of the Manager it would be in the best interests of the fund.”
Id.
Thus, Bayou Superfund had the right to delay payment of the High Sierra redemption until the end of July 2005.
High Sierra did not receive its requested $9.8 million redemption by April 30, 2005. But it did receive redemption payments aggregating $8.3 million within the next three weeks, as follows: $3.8 million on May 2; $2 million on May 3; $1 million on May 4; and $1.5 million on May 23. During this period High Sierra made redemption payments to its Redacted Investor of $9.64 million on April 19, $13 million on April 28 and $3.7 million on May 3, 2005.
It is conceded that “Plaintiffs do not contend that High Sierra Investments (‘High Sierra’) was on ‘inquiry notice’ at the time it
submitted
its initial partial redemption request in March 2005.” Plaintiffs’ Omnibus Memorandum of Law at 202. Plaintiffs also concede that High Sierra’s sole reason for requesting partial redemption of its Bayou Superfund investment and two other investments was to raise cash in order to honor the request for redemption by its own Redacted Investor. These undisputed facts establish High Sierra’s good faith defense under Section 548(c) as a matter of fact and law.
Plaintiffs’ claim against High Sierra is predicated entirely on the fact that High Sierra did not receive its redemption payment by Friday, April 29. But High Sierra did receive redemption payments aggregating $6.8 million on May 2, 3 and 4, and a final payment of $1.5 million on May 23. Not surprisingly, the brief delay beyond the expected April 29 payment date caused a flurry of emails and phone calls emanating from a representative of High Sierra, squeezed for cash by its redemption payments to its own Redacted Investor, resulting in excuses and evasions from the Bayou employees. But it was not until May 19 that two representatives of Jones Commodities (an entity which served as the general partner of High Sierra) addressed separate emails to Bayou Super-fund reflecting a concern about the financial condition of Bayou Superfund. High Sierra’s concern about the financial condition of Bayou is also reflected in the fact that on that date, May 19, High Sierra reinstated its request for full redemption of its entire Bayou Superfund account, contradicting High Sierra’s statement in early March that it “look[ed] forward to a LONG standing relationship with Bayou.”
The brief delay between April 29 and the payments on May 2, 3 and 4 aggregating $7.3 million did not constitute either objectively or subjectively a “red flag” putting High Sierra on “inquiry notice” of the Bayou financial condition or fraud. Viewed objectively, the delay was
de min-imis
and Bayou had the contractual right to defer redemption payment for up to ninety days after April 29. High Sierra’s emails and phone calls through May 4 reflected its urgent need for cash resulting from its own redemption payments to its Redacted Investor, and there was no objective evidence of any reason for High Sierra employees to think that this brief delay was anything other than a temporary liquidity issue, such as High Sierra itself was facing.
*858
The evidence proffered by plaintiffs with respect to May 19 — the emails sent by Jones Commodities representatives to Bayou and High Sierra’s decision on that date to demand redemption of the balance of its Bayou Superfund account — do reflect High Sierra’s subjective concern with respect to the financial condition of Bayou and, in fact, that concern did provoke inquiry and request for financial data by Jones Commodities on behalf of High Sierra. That evidence would certainly appear to undermine High Sierra’s ability to sustain a good faith defense in respect of its May 19 request for redemption of the balance of its Bayou Superfund account. But that issue is not before the Court, since the May 19 request did not result in any redemption payment.
The only remaining issue is whether the May 19 evidence may be invoked by plaintiffs to undermine High Sierra’s established good faith defense in respect of the last partial payment on May 23 of $1.5 million on its March 2 request for partial redemption. I conclude that the good faith defense effective in March may not be revoked by the Court
nunc pro tunc
by post hoc events in May. The concern experienced by High Sierra with respect to Bayou’s financial condition by May 19 resulting from the delay in expected payments does not taint High Sierra’s conceded good faith in requesting a $9.8 million partial redemption in early March. As acknowledged by plaintiffs, “High Sierra’s understanding at the time was that its March 2, 2005 redemption request would be effective at the end of March 2005, meaning that ‘our $9.8 million would be removed from Superfund, by Superfund, effective at the end of 3/31/05, and not invested anymore.’ ” Plaintiffs’ Omnibus Memorandum of Law at 206. Under the Bayou Hedge Funds’ Operating Agreement, the parties regarded a request for redemption as irrevocable after the effective date of the redemption at the end of the month during which the request was made.
See
Plaintiffs’ Omnibus Memorandum at 83-85.
A redeeming investor “takes” his redemption based upon the facts and circumstances known to him on the date that he makes his request for redemption. There is no legal or equitable basis for the Court to revoke the investor’s good faith defense based upon facts or events unknown to the investor when he made his decision.
3.
Michael Mann (Adv.Proc. No. 06-08419)
The Section 548(c) defense of Michael Mann is established on the facts alleged, and those not alleged, in plaintiffs’ own submissions
(i.e.,
the Omnibus Memorandum at 183-186, Omnibus Reply Memorandum at 74-75 and Rule 56.1 Statement of Material Facts at ¶¶ 1102-1123). Mann’s Section 548(c) defense is that he made his own decision to request redemption of his $500,000 Bayou hedge fund investment shortly after he invested in January 2005 and that he had no knowledge of any red flags putting him on inquiry notice of fraud or financial issues at Bayou. While plaintiffs’ factual account differs in some respects from that of Mann, nowhere in their three submissions do plaintiffs assert that Mann had knowledge or information of any red flags putting Mann on inquiry notice.
Plaintiffs’ allegations respecting Mann are summarized in Plaintiffs’ Omnibus Memorandum at 193-194 (citations to the record omitted; emphasis in original):
Mann was an investor in Sterling Sta-mos in 2004 and 2005. On January 1, 2005, Mann made a direct investment of $500,000 in Bayou Superfund based on a referral from Peter Stamos. Mann asked Stamos if there were “investments in [Sterling Stamos’s] funds that [Mann] could make directly.” In response, Pe
*859
ter Stamos provided Mann with a number of funds, including the Bayou Hedge Funds. Stamos assured Mann that, although he was “not authorized” to give Mann “advice to invest in any single manager or to divest from any manager,” he would
“keep [Mann] informed as to with whom we had invested and when we chose to redeem.”
Other than reviewing a set of marketing materials received from Bayou Superfund, Mann did not conduct any other due diligence or research prior to investing in Bayou Superfund.
Peter Stamos kept his promise to inform Mann as to when Sterling Stamos “chose to redeem” from the Bayou Hedge Funds. On February 14, 2005— while Mann was on vacation in Barbados — Peter Stamos “called [Mann] to tell him that we had decided to redeem [from Bayou].” Mann immediately responded to Peter Stamos that “if you all are ... redeeming, then I will redeem as well.” Mann never performed any further investigation into the Bayou Hedge Funds.
Promptly thereafter, representatives of Sterling Stamos assisted Mann in his redemption, including preparing and faxing to Mann at his hotel in Barbados a redemption notice for Mann to sign, which Mann received, signed and faxed to Bayou the same day. When he returned from vacation the following week, Mann wrote an email to Bayou to confirm his redemption notice stating: “[A]s you know I was brought to your fund by [P]eter [S]tamos. [S]ince they are pulling out their funds for particular reasons, I am doing the same.” Plaintiffs conclude their recitation of facts concerning Mann with the following paragraph:
Based on the foregoing undisputed facts, Mann cannot sustain his affirmative defense of statutory “good faith” under section 548(c) because he was on “inquiry notice” and failed to conduct a “diligent investigation” at the time he took the Redemption Payment.
Id.
at 196.
The problem with this conclusory assertion is that nowhere do plaintiffs explain by allegation of any facts what it was that Mann was on “inquiry notice” of, and nowhere do plaintiffs allege that Mann had knowledge of any “red flag” putting him on notice of any fraud or financial distress at Bayou, such as the
Westervelt
lawsuit, which was the red flag which plaintiffs point to with respect to Sterling Stamos.
See
point III D 3, below. The only reference in plaintiffs’ submissions respecting what Sterling Stamos told Mann on February 14 appears in the Omnibus Reply Memorandum at 74:
According to Mann, he was told that Sterling Stamos “was not happy with the infrastructure at Bayou.”
Lacking explanation by plaintiffs, only two postulates suggest themselves as a predicate for plaintiffs’ conclusory allegation that Mann was “on inquiry notice.” One is that Sterling Stamos’ decision to redeem its investments in the Bayou hedge funds was by itself a “red flag” warning signal of fraud or financial problems at Bayou. I reject this postulate because there could have been any number of reasons for the Sterling Stamos Funds to redeem their Bayou investments, including liquidity issues such as prompted High Sierra to divest itself of its Bayou investment. The other postulate — that Sterling Stamos’ knowledge of red flags, including the
Westervelt
lawsuit, should be imputed to Mann even though there is no evidence that Mann had Information concerning
Westervelt
or any other red flags — must also be rejected. Sterling Stamos was not acting as broker, financial advisor or agent in any respect on behalf of Mann. The fact that Peter Stamos, in response to an inquiry from Mann, advised Mann of several hedge funds in which the Sterling Stamos
*860
hedge funds were invested in which Mann could invest on his own, and that Stamos said he would inform Mann if and when Sterling Stamos decided to divest any of those investments and did so, did not give rise to any agency or other relationship such that Sterling Stamos’ knowledge could be imputed to Mann.
When Mann proffered his affirmative defense of good faith under Section 548(c), the burden shifted to the plaintiffs to rebut that defense by evidence that Mann had knowledge of red flags putting him on inquiry notice of problems at Bayou. Plaintiffs have not met that burden, and Mann is entitled to summary judgment dismissing the claim against him in respect of his investment in Bayou.
D.
Issues of fact requiring a trial
Plaintiffs have acknowledged in respect of nine adversary proceedings, and I have concluded in respect of four additional adversary proceedings, that there are issues of fact requiring a trial to resolve the defendants’ good faith defenses under Section 548(c). This does not affect plaintiffs’ right to summary judgment against these defendants to recover fictitious profits in accordance with this Court’s rulings under point II D 1 and 2, above.
1.
William Strang (Adv.Proc. No. 06-08387) Randall M. and Shergl B. Rothstein (Adv.Proc. No. 06-08389) Alan Osofsky (Adv.Proc. No. 06-08398) DW Resources DBP and Marc Daniels (Adv.Proc. No. 06-08415) Marc Fleisher IRA and Marc Fleisher (Adv.Proc. No. 06-08423) Kevin Bass (Adv.Proc. No. 06-08431) Michael Davidson (Adv. Proc. No. 06-08435) Neil D. Cohen (Adv.Proc. No. 07-08245) Edward and Virginia Sorkin (Adv.Proc. No. 07-08246)
Plaintiffs’ claims against these nine defendants (the “Kra defendants”) arise from their relationship with Howard Kra (“Kra”), a former Bayou sales employee who marketed Bayou hedge funds to his friends and former brokerage clients. It is alleged that Kra’s largest source of introduced accounts, Lydian Wealth Management, became aware of an FBI investigation of Bayou, informed Kra, and advised its own clients to redeem their Bayou investments. Shortly thereafter Kra resigned from Bayou, and he and all his clients redeemed their Bayou investments. Eighteen Lydian-related Bayou investors who redeemed have settled adversary proceedings commenced by plaintiffs. Kra himself and five of his clients who redeemed have settled with plaintiffs.
The nine Kra defendants listed above deny that they were “tipped” by Kra and have moved for summary judgment based,
inter alia,
on their good faith defenses under Section 548(c).
Plaintiffs acknowledge that there are material issues of fact requiring a trial on all of the Kra defendants’ affirmative defenses under Section 548(c). Because I agree that the facts relevant to the 548(c) defenses are in dispute, the cross-motions for summary judgment of the Kra defendants are denied.
2.
Mary Jane Pidgeon Sledge (Adv. Proc. No. 06-08339)
Mary Jane Pidgeon Sledge (“Sledge”) and her husband were clients of the investment advisory firm Consulting Services Group (“CSG”).
See
point III E 3, below. In December 2003 Mr. Sledge died. Because Sledge was then in her mid-seventies and in uncertain health, her daughter, Phillipa, assumed control of Sledge’s financial affairs.
On June 28 , 2004 Sledge received a fax from CSG (apparently unsolicited) with a
*861
redemption form for Bayou. Phillipa arranged for her mother to sign the redemption form covering the whole of the Sledges’ investments in Bayou hedge funds and faxed the form back to CSG.
On the basis of the facts summarized in point III E 3 below, a June 25 letter to Sledge from CSG, a conversation on June 28 between a representative of CSG and Sledge and a conversation between an accountant and Sledge, plaintiffs assert that Sledge cannot sustain her burden of proof on a good faith defense under Section 548(c). Sledge and Phillipa deny receipt of the June 25 letter from CSG, deny any conversation with a representative of CSG in June 2004 and do not recall the conversation with the accountant as alleged by plaintiffs. Phillipa has testified that she decided in January 2004 to redeem her family’s investment in Bayou and other hedge funds at what she believed to be the next semiannual redemption date, and Phillipa and Sledge deny having any knowledge of any of the red flags which caused CSG to recommend redemption of their Bayou investments to their clients.
The dispute of facts regarding Sledge’s redemption requires a trial.
3.
Sterling Stamos Funds (Adv.Proc. No. 06-08493)
Each of the four Sterling Stamos Funds is a fund of funds. Between April 2003 and October 29, 2004 the four Sterling Stamos Funds had invested an aggregate of $15.7 million in various of the Bayou hedge funds. In November 2004 a representative of TAG Associates, an investment advisor and a hedge fund manager, sent Sterling Stamos a copy of a complaint filed by Paul Westervelt, a former “principal” or “partner” of the Bayou Management entity, against Samuel Israel alleging that Israel and Bayou engaged in SEC violations and other financial improprieties, that Westervelt as a Bayou “partner” was precluded from access to Bayou financial records, and that he was fired when he sought explanations from Israel and Marino.
See
point III E 2, below. The TAG Associates representative advised Sterling Stamos that TAG Associates intended to redeem its Bayou investment because of failure to get a satisfactory explanation of the
Westervelt
complaint from Israel. After receiving the
Wester-velt
complaint from TAG Associates, Sterling Stamos decided to increase its due diligence concerning Bayou and obtained two background investigative reports. A Sterling Stamos representative also inquired of Israel who advised that Wester-velt was just a disgruntled employee and the case had been settled.
Apparently unperturbed by the
Wester-velt
complaint and the two investigative reports, the Sterling Stamos Funds invested an additional $14 million in Bayou hedge funds between early December 2004 and early February 2005, bringing its total Bayou investment to $29.7 million.
On February 7, 2005 a new General Counsel and a new Associate General Counsel joined Sterling Stamos. New counsel reviewed the due diligence file on Bayou, including the
Westervelt
complaint, and concluded that a number of questions suggested by the due diligence materials should be put to Israel at a meeting with Israel and other Bayou representatives which had previously been scheduled for February 9, 2005.
At the February 9 meeting Peter Sta-mos expressed “concerns ... about the strength of [the Bayou] organization” and made three suggestions regarding “organizational issues.” Israel responded favorably to the Stamos recommendations, told Sterling Stamos that he intended to implement all three suggestions and reported enthusiastically that he was considering trading in asset classes other than equities and that he was considering creating a
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“new bigger fund.” Near the end of the February 9 meeting Sterling Stamos’ new General Counsel asked Israel questions raised by the
Westervelt
complaint and other due diligence obtained by Sterling Stamos. Israel became irritated and was “dismissive of’ the General Counsel’s questions, and he did not provide answers.
After the February 9 meeting with the Bayou representatives, Peter Stamos met privately with his new General Counsel and other Sterling Stamos officials who were present at the February 9 meeting. The General Counsel advised that his “gut feeling [was] that [Sterling Stamos] should not be investing with Bayou and Sam Israel,” and he advised another Sterling Sta-mos partner that “he would redeem” Sterling Stamos’ Bayou investments.
After considering the views of Sterling Stamos’ General Counsel and other representatives present at the February 9 meeting, Peter Stamos made the decision to redeem the entire investment of all four Sterling Stamos Funds. Notice of the redemption was given on February 11, 2005.
In addition to the fact that Sterling Sta-mos was on objective notice of the
Wester-velt
complaint and other facts learned in the course of due diligence, as well as Israel’s “dismissive” refusal to respond to questions by General Counsel at the end of the February 9 meeting, plaintiffs rely on two additional events which occurred after Sterling Stamos’ February 11 notice of redemption. One was Bayou’s “unethical” proposal, tendered one week before the initial deadline to make the redemption payments, that if Sterling Stamos would revoke their redemption notice of February 11 Sterling Stamos would be entitled to participate in Bayou’s profitability for March. The Bayou proposal was recognized as “unethical” because after Sterling Stamos’ February 11 redemption, effective at the end of February, the Sterling Funds would no longer be eligible to participate in the putative March gains and therefore would be taking participation in the March gains away from the remaining investors. The other post-redemption factor claimed to put Sterling Stamos on inquiry notice was that its redemption payments were spread over nine wire transfers on March 31 and April 1, one and two days past the thirty-day contractual deadline.
Sterling Stamos denies that the reason it redeemed its Bayou investments was the
Westervelt
complaint and other due diligence or Israel’s dismissive response to questions at the February 9 meeting raised by Sterling Stamos’ General Counsel, asserting:
The reasons the Sterling Funds redeemed from Bayou are well documented. Seven different current or former Sterling Funds employees testified as to those reasons, and all confirmed that the Sterling Funds redeemed because of (i) Bayou’s intent to trade not just U.S. listed equities, but also commodity futures, a different and more volatile asset class (“style drift”); (ii) Bayou’s intent to quadruple its assets under management (“asset growth”); and (iii) the strain that such style drift and asset growth would place on Bayou’s infrastructure.
Memorandum of Law of the Sterling Funds at 49.
In their Omnibus Reply Memorandum, plaintiffs object that the Sterling Stamos submission was “mostly concerned with] the
subjective
reason that the Sterling Stamos Funds submitted their complete redemption from the Bayou Hedge Funds in February 2005,” arguing that “Sterling Stamos’s subjective intent is irrelevant.” Omnibus Reply Memorandum at 66. Noting Sterling Stamos’ acknowledgment that “the facts that are presented [by plaintiffs] are undisputed,” plaintiffs argue that “[t]hose undisputed facts are sufficient on their own to preclude Sterling Stamos’s
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affirmative defense, as they establish that Sterling Stamos was on objective inquiry notice prior to taking the redemption payments.”
On its face, plaintiffs’ argument (excluding the contentions based on Bayou’s post-redemption “unethical” offer and the
de minimis
delay in redemption payments, both of which I reject as a matter of law for reasons explained above) is very persuasive. Going into the February 9 meeting, Sterling Stamos was certainly on inquiry notice of serious issues involving Bayou raised by the
Westervelt
complaint and the two investigative reports obtained following receipt of the
Westervelt
complaint. Viewed objectively, Israel’s eon-cededly “dismissive” responses, indeed refusal to respond, to General Counsel’s questions at the end of the February 9 meeting could only have increased, rather than allayed, the concerns raised by the red flags which were known to Sterling Stamos.
But plaintiffs ignore a salient fact which distinguishes this unusual case. Sterling Stamos representatives were in possession of the
Westervelt
complaint and the two investigative reports in November 2004 and conducted such due diligence inquiries as occurred to them, and whatever concerns they may or should have had were sufficiently set to rest that Sterling Stamos increased its investments in Bayou hedge funds by $14 million during December, January and early February 2005. That fact is conclusively established by the objective evidence of the Sterling Stamos’ purchases in December-February. Had Sterling Stamos not increased its investment in the Bayou hedge funds between December and February, I would agree that under the objective standard test Sterling Stamos’ protestations of a subjective, unverifiable good faith purpose for redemption would not suffice, since Israel’s dismissive refusal to answer questions at the February 9 meeting objectively exacerbated the concerns that prompted the questions. However, as previously noted under point III A, above, an evaluation of good faith may include objective evidence of the transferee’s subjective intent or good faith. Here, Sterling Stamos’ investment of an additional $14 million despite knowledge of all of the red flags which concerned its General Counsel at the February 9 meeting certainly constitutes objective evidence that the Westervelt red flags did not motivate Sterling Stamos to seek redemption, at least not until after February 9 when Israel evaded the hard questions in the presence of Peter Stamos and his associates.
By the same token, however, the Sterling Stamos Funds’ investments in Bayou during December-February do not mandate summary judgment on their cross-motions for summary judgment. That is because Sterling Stamos’ newly-hired General Counsel and Associate General Counsel reexamined the Bayou due diligence materials, questioned Israel at the February 9 meeting and apparently recommended redemption based on Israel’s “dismissive” refusal to respond.
A trier of fact may, or may not, believe Peter Stamos’ “good faith” explanation that the February 11 redemption notice was based solely on concerns over organizational or structural issues or Israel’s expressed intent to expand the scope of Bayou’s investment strategy, and not on the Westervelt red flags and Israel’s refusal to answer questions, which obviously motivated his new General Counsel. But the issue of fact should be resolved by a trier of fact on the basis of a full trial record.
4.
Highgate Partners LP (Adv.Proc. No. 06-08412)
Highgate Partners LP (“High-gate”) is a fund of funds which is “a single-person operation” that “is owned and oper
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ated exclusively by Ms. [Ellen] Horing,” and Horing “is also Highgate’s sole employee” (quoting from Highgate’s Memorandum of Law at 2, 3).
Horing became a partner in Sterling Stamos in late 2002/early 2003. Because of family demands, Horing arranged with Sterling to change her status to that of a withdrawing partner. As such, Horing had the right to share in Sterling Stamos’ cash flow at a reduced rate over a number of years, but she had no continuing direct operational responsibility at Sterling Sta-mos and was no longer expected to go into the Sterling Stamos offices on a regular basis. Horing conducted Sterling Stamos’ due diligence concerning the Bayou hedge funds in 2003 and 2004, including reviewing the Bayou hedge funds’ operating agreements, subscription documentation and marketing materials, conducting reference checks and attending meetings at Bayou’s offices. Sterling Stamos’ internal records identify Horing as the “source” of Sterling Stamos’ Bayou investment. Both Sterling Stamos and Highgate made their initial investments in the Bayou hedge funds within the same week of each other in late March or early April 2003.
Highgate invested $850,000 in Bayou Su-perfund in April 2003. Highgate requested redemption of its entire investment in Bayou Superfund on February 11, 2005, the same date as the Sterling Stamos request for redemption, and received redemption payments in the amount of $981,000.
Horing attended the February 9, 2005 meeting between Sterling Stamos representatives and Israel and other representatives of Bayou. Horing made the decision to redeem Highgate’s investment in Bayou immediately following the February 9 meeting, and she informed the Sterling Stamos General Counsel of her decision to redeem “as she was walking out” of the February 9 meeting.
Horing denies that her decision to redeem Highgate’s Bayou Superfund investment was motivated by any concern over the
Westervelt
lawsuit or Israel’s “dismissive” refusal to respond to the questions concerning Westervelt put to him by Sterling Stamos’ new General Counsel. Hor-ing’s rationale for her decision to redeem is expressed as follows in Highgate’s Memorandum of Law at 5:
After hearing these significant developments [Israel’s announcement that he intended to grow “the Bayou fund” from approximately $500 million of net asset value to a range of $1 to $2 billion and planned to move into commodity short-term trading], Ms. Horing decided to withdraw her investment. Both strategic changes announced by Israel were, to Ms. Horing, problematic. Vastly increasing the size of the fund would have made it more unwieldy and would have over stressed the existing Bayou infrastructure. Moreover, short-term commodity trading involves a different skill-set than the short-term equity trading in which Mr. Israel had established his reputation. Ms. Horing had seen other examples of this type of “style drift” and the results were often disappointing. Accordingly, Ms. Horing thought the prudent course was to exit Bayou, at least until Israel could demonstrate his competence in this different trading discipline, with a significantly larger fund.
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Unlike the Sterling Stamos funds, Hor-ing did not increase Highgate’s investment in the Bayou hedge funds after learning of the
Westervelt
lawsuit in October 2004. But Horing’s continuing close relationship with Sterling Stamos and the fact that she did not seek to redeem Highgate’s investment in Bayou Superfund until after the February 9 meeting gives rise to the same issue of fact requiring a trial as in the adversary proceeding against the Sterling Stamos defendants, namely, whether these defendants’ decision to redeem after the February 9, 2005 meeting was in fact motivated by Israel’s optimistic and expansive plans for the Bayou funds or by Israel’s dismissive refusal to answer questions concerning the Westervelt charges. That issue should be decided by a trier of fact on a full trial record.
E.
Summary judgment granted for plaintiffs
Before turning to the specific facts pertaining to the individual defendants against whom summary judgment is to be granted rejecting their 548(c) defenses, it will be useful to examine the “inquiry notice” due diligence performed by two investment ad-visors during 2004, and the “red flags” which provoked them, which have a significant bearing on the parties’ contentions on the pending motions and cross-motions for summary judgment. One is the Altegris due diligence and the other is the
Wester-velt
complaint and resulting due diligence performed by CSG.
1.
Background: the Altegris due diligence
Altegris Investments (“Altegris”) is a registered broker-dealer which offers a platform of hedge funds and commodity pool products to qualified investors. In early 2002 Altegris entered into a selling agreement with Bayou Management and began recommending the then-existing Bayou Fund to its clients. In late 2003 or early 2004, after the original Bayou Fund had been closed, Altegris had discussions with Bayou Management about entering into a selling agreement for the new Bayou hedge funds. It appears that at a meeting on June 17 , 2004 Altegris learned that Bayou’s off-shore administrator was not independently preparing net asset values (NAVs), but that Marino was providing “all the financial information required for the calculation of the NAVs.” Altegris was told that, other than the annual audits by Richmond-Fairfield, “no other independent outside parties are looking at monthly NAVs.”
Upon learning that the Bayou hedge funds were calculating their own NAVs, Altegris asked Marino to allow Altegris to conduct its own verification of NAVs, including reviewing the Bayou hedge funds’ monthly prime broker statements. Mari-no refused this request and subsequent requests “to give Altegris month-end asset transparency” by allowing Altegris to conduct “a simple check on assets and monthly NAVs.” Accordingly, Altegris decided in July 2004 to conduct further due diligence including a review of the Bayou hedge funds’ audited financial statements and contact with the Bayou hedge funds’ auditor, Richmond-Fairfield. As part of that due diligence, Altegris searched the New York Department of State records to determine whether Richmond-Fairfield was a registered accounting firm. That search disclosed that Marino was the “Registered Agent” for Richmond-Fairfield. After a telephone conversation with Marino on July 6, 2004, Altegris addressed the following written communication to Marino:
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Dan — Further to our telephone conversation today, please provide a written explanation of your relationship with Richmond Fairfield. Specifically, this should include the history of the firms; the relevant dates of your involvement; the details regarding your exit from Richmond Fairfield and start with Bayou; and the retention of Richmond Fair-field by Bayou to prepare annual audits. You might also address why the New York Society of Accountants still records you as the member/manager for Richmond Fairfield, and also has no record of either Dan or Matt Richmond. Please reply as soon as possible on these issues.
Two days later, on July 8, 2004, Altegris contacted its clients who were invested in Bayou hedge funds recommending that they redeem their Bayou investments, explaining that Altegris was “becoming increasingly uncomfortable” because of a “continued lack of transparency,” and “questions regarding [Bayou’s] recent audit that have remained unanswered.”
16
The Altegris due diligence is relevant to these contested adversary proceedings because it graphically undermines the contentions of a number of defendants, referred to above, that no reasonable due diligence could have discovered the Bayou fraud. To the contrary, a simple inquiry by Altegris concerning the method by which the Bayou hedge funds’ NAVs were calculated and controlled, and Marino’s responses, promptly revealed to Altegris (i) that Bayou Management’s representation in the published financials that Richmond-Fairfield was an independent accounting firm was false, (ii) that Marino was a principal, apparently the only principal, of Richmond-Fairfield, (iii) that there was no independent audit or review of the Bayou hedge funds’ published NAVs and other financial reporting and (iv) that Bayou would not permit Altegris to conduct its own audit or independent review of the Bayou hedge funds or to examine the prime brokerage and bank statements which should have been the source of the Bayou NAVs, but in fact were not because Israel and Marino simply made up fictitious numbers. These facts did not reveal the full scope or detail of the Bayou fraud, but they did reveal the fact that there was a fraud — the fact that Richmond-Fairfield as an independent auditing firm was a fiction and a gross misrepresentation; the fact that Bayou prepared its own NAVs without' independent review; the fact that Bayou would not permit an entity which was a Bayou sales representative with many clients invested in Bayou funds access to the primary source documents which' would verify or contradict Bayou’s published financial statements.
The Altegris facts also illuminate the concept of “good faith” as used in Section 548(c) of the Bankruptcy Code. There is not a single element of “bad faith” or misconduct of any sort on the part of Altegris or its clients. Quite the contrary, the Altegris due diligence and recommendation to its clients to divest their Bayou investments, and the decisions of all Alteg-ris clients to redeem their Bayou investments, were in every respect proper and entirely reasonable in the circumstances. The good faith requirement was not designed by Congress nor has it been interpreted by the courts to deter or sanction misconduct. Like Section 547, which requires innocent creditors to refund payments of money owed to them within ninety days of a bankruptcy filing, Section 548 seeks to promote a limited degree of equality of treatment among creditors (in
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this case, defrauded investors in the Bayou hedge funds) by requiring redeeming investors to return transfers found to be fraudulent on the part of Bayou management under subsection (a) unless the redeemers can establish that they received such transfers “in good faith” under subsection (c),
i.e.,
without being on inquiry notice of some infirmity on the part of the transferor.
2.
Background: the Westervelt complaint
For Altegris the red flag provoking the inquiries which led swiftly to the revelation of the Bayou fraud was the discovery that Marino was preparing the NAVs for one of the Bayou offshore funds. For Consulting Services Group (“CSG”) and its closely-related hedge fund manager, Centennial, the initial red flag was the
Westervelt
complaint (P-CSG Ex. 15), which was filed on March 26, 2003 in the United States District Court for the Eastern District of Louisiana.
The plaintiffs in that case were Paul T. Westervelt, Jr. (“Westervelt”) and his son Paul T. Westervelt, III. The defendants were Bayou Management, L.L.C., Bayou Funds, Bayou Securities, L.L.C., Dan Marino and Sam Israel, III. The complaint alleged that Westervelt “had for 33 years been engaged in the business of investment management, investment counseling and fund management in and around the City of New Orleans and had established an excellent reputation, both personally and professionally, as being very successful in those fields, with particular expertise in hedge fund management.” Westervelt had provided a wide variety of investment services “for which he was justifiably well-compensated” by the Johnson Rice and Company of New Orleans. In the summer of 2002 Israel approached Westervelt to leave his employer and join forces with Israel, Marino and Bayou. Over several months of negotiations, Israel and Marino “actively recruited Westervelt to become a principal and shareholder in Bayou.” The complaint alleges that Israel, Marino and Westervelt reached an agreement, documented by letters of intent dated September 30, 2002, under which “Bayou agreed to pay Westervelt $800,000.00 per year through October 31, 2007, and convey to him an immediate 25% ownership interest in Bayou Management, L.L.C., to b
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