Free Motion for Partial Summary Judgment - District Court of Arizona - Arizona

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Guttilla & Murphy, PC
Firm No. 00133300 Ryan W. Anderson (No. 020974) Alisan M. B. Patten (No. 009795) 4150 West Northern Ave. Phoenix, Arizona 85051 (623) 937-2795 [email protected] [email protected]

Attorneys for the Receiver IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF ARIZONA Lawrence J. Warfield, Receiver, Plaintiff, v. Michael Alaniz, et al. Defendants. ) ) ) ) ) ) ) ) ) ) ) ) ) ) Cause No. CV 03-2390 PHX JAT Receiver's Motion for Partial Summary Judgment on Count Nine against Defendants: Leonard and Elizabeth Bestgen, Renald Bidwell, Robert Carroll, Rudy and Mary Crosswell, Charles Davis, Richard Derk, Orville Dale Frazier, Ronald Allen Kerher, Dwight Lankford, John and Candes Rada, Paul Richard and Patrick Wehrly

10 11 12 13 14

I. Introduction 15 Lawrence J. Warfield, Receiver, pursuant to Rule 56(a) Fed. R. Civ. P., hereby 16 moves for partial summary judgment against Defendants Bestgens, Bidwell, Carroll, 17 Crosswells, Davis, Derk, Frazier, Kerher, Lankford, Radas, Richard and Wehrly 18 ("Defendants") on the Receiver's actual fraud claim under Count Nine (Fraudulent 19 20 21 22 23 The Receiver is not moving at this time on his "constructive fraud" claims under Court Nine. Instead, the Receiver's motion is limited to seeking judgment on his "actual fraud" claim under Ariz. Rev. Stat. ("A.R.S") §44-1004(A) (1) not the "constructive fraud" claim under A.R.S. §44-1004(A) (2) or §44-1005.
Document 464 Filed 12/29/2005 Page 1 of 38
1

Transfer)1 of the Receiver's Third Amended Complaint.

Case 2:03-cv-02390-JAT

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

II. Synopsis of Receiver's argument. Robert Dillie operated a large scale Ponzi scheme using Mid-America Foundation, Inc. ("MAF") and Mid-America Financial Group, Inc. ("MAFG") as the means by which he could market and sell fraudulent charitable gift annuities ("CGAs") to the public. Defendants, all of whom claim to have been licensed insurance agents at the time they sold CGAs [and three of whom also claim to have been licensed to sell securities] were paid commissions by MAF or MAFG (using MAF moneys) for selling the fraudulent MAF charitable gift annuities ("MAF CGAs") primarily to senior citizens (i.e., people who are sixty-five years of age or older) ("the Victims") in States around the country including the States of Arizona, California, Florida, Illinois, Maine, Massachusetts, South Dakota, Texas and Washington. The mere existence of a Ponzi2 scheme conclusively establishes as a matter of law that the commission payments to Defendants were made with the actual intent to hinder, delay or defraud the creditors of MAF (including the defrauded Victims of MAF) and, as such, were fraudulent transfers. Although a "good faith" affirmative defense is available to fraudulent transfer claims that are based upon actual fraud, a "good faith" defense is unavailable to the Defendants. Defendants cannot sell in "good faith" fraudulent MAF CGAs after having failed to obtain an audited financial statement verifying MAF's financial condition before they sold the CGAs to a vulnerable public. The Defendants'
2

10 11 12 13 14 15 16 17 18 19 20

"A Ponzi scheme is an arrangement whereby an enterprise makes payments to 21 investors from the proceeds of a later investment rather than from profits of the underlying business venture, as the investors expected. The fraud consists of transferring 22 proceeds received from the new investors to previous investors, thereby giving other investors the impression that a legitimate profit making business opportunity exists, exists." In re Agricultural Research And Technology 23 where in fact no such opportunity th Group, Inc., 916 F.2d 528, 531 (9 Cir. 1990). Case 2:03-cv-02390-JAT Document 464 2Filed 12/29/2005 Page 2 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

decision to not make a proper inquiry about MAF's financial condition or to blindly accept what was told to them by representatives of MAF destroys any "good faith" defense. Additionally, all Defendants violated one or more federal or state laws regulating the sale of MAF CGAs. This alone, or in combination with the Defendants' failure to obtain an audited financial statement before selling the MAF CGAs, likewise defeats any assertion of a "good faith" defense by Defendants. Accordingly, based upon the undisputed facts of this case, summary judgment on Count Nine of the Receiver's Third Amended Complaint should be granted in favor of the Receiver. III. Standard for Granting Motion for Summary Judgment In considering a summary judgment motion on a fraudulent transfer claim the Receiver, as Plaintiff, bears the burden of proof. However, the Defendants bear the burden of proof in establishing the affirmative defense of "good faith." In re Agricultural Research and Technology Group, Inc., supra, 916 F.2d at 539 (9th Cir. 1990). (The case of In re Agricultural Research and Technology Group, Inc., supra, was based, in part, upon Hawaii's law regarding fraudulent transfers. Like Arizona and all other states in which the Defendants sold MAF CGAs, as more fully discussed, infra, the state of Hawaii based its fraudulent transfer statutes upon the Uniform Fraudulent Transfer Act including the "good faith" defense offered to qualifying transferees. See, Haw. Rev. Stat. §651C-4(a)(1) (1985) and §651C-8(a) (1985).) See also, Quilling v. Gilliland, 2002 WL 373560 (D.C. Tex. 2002) holding that the transferee of an alleged fraudulent transfer has the burden of proof in establishing a "good faith" defense.

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

Document 464

3Filed 12/29/2005

Page 3 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

IV. A "Conflict of Law" Analysis is Unnecessary. A conflict of laws analysis might be appropriate to determine which state's fraudulent transfer statute is applicable. Although the Receiver's position is that Arizona's law applies to the recovery of transfers from Arizona,3 a resolution of the issue is unnecessary because the states in which the Defendants sold the MAF CGAS, i.e., Arizona, California, Florida, Illinois, Maine, Massachusetts, South Dakota, Texas and Washington, have all adopted the same pertinent provisions of the Uniform Fraudulent Transfer Act ("UFTA") §4(a)(1) (1984). See, Ariz. Rev. Stat. §44-1004(A)(1) (1990); Cal. Civ. Code §3439.04(a)(1) (West 1986)4; Fla. Stat. Ann. §726.105(1) (a) (West 1997); 740 Ill. Comp. Stat Ann. §160/5(a)(1) (West 1991); 14 Maine Rev. Stat. Ann. §3575(1)(A) (West 1985); Mass. Gen. Laws Ann. 109A §5 (West 1996); S.D. Codified Laws §54-8A-4(a)(1) (1987); Vernon's Texas Code Ann., Business and Commerce Code, §24.005(a)(1) (West 2002) (which was in the same form between 1993-2002); and Rev.

10 11 12 13 14 15 16 17 18 19 20 21 22 23

See, e.g., Restatement (Second) of Conflict of Laws, §§ 6, 145 (1971). The Court in Bill Alexander Ford, Lincoln Mercury, Inc. et al. v. Casa Ford, Inc., 187 Ariz. 616, 618, 931 P.2d 1126, 1128 (Ariz. App. 1997) held: "Arizona courts follow the Restatement (Second) of Conflict of Laws (1971) to determine the controlling law for multistate torts. (Citation omitted.) The law which applies is that of the state with the most significant relationship to the occurrence and to the parties. (Citations omitted.)" MAF operated out of the State of Arizona. (See SOF, F.1.a.iii.; F.3.a.iv.; F.5.a.ii.; F.7. a.iv.; F.9.a.i.F.; F.12.a.iv.; F.12.b.vi.; F.15.a.xiv.; F.17.a.iv.; F.17.b.iv.; F.17.c.vi.; F.17.d.v.; F.18.d.v. -all showing correspondence and bank documents showing MAF and MAFG operated out of Arizona. The California statute was amended in 2004 to add a non-exclusive list of factors that may be considered in determining the "actual intent" requirement of Cal. Civ. Code §3439.04(a) (1) (West 2004).
Document 464
4

3

Case 2:03-cv-02390-JAT

4Filed 12/29/2005

Page 4 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Code Wash. Ann., Business Regulations, §19.40.041(a)(1) (West 1987). Each of these statutes is identical or nearly identical to the UFTA provision which states the following:5 A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation . . . [w]ith actual intent to hinder, delay, or defraud any creditor of the debtor . . . . UFTA §4(a)(1); A.R.S. §44-1004(A)(1) V. MAF Funds Were Transferred to Defendants with the Actual Intent to

Hinder, Delay or Defraud Creditors. A. Background of the Ponzi scheme. In this Dillie-orchestrated Ponzi scheme, MAF Victims were led to believe that the purchase of a MAF CGA would provide them with a stream of income during the life of the annuitant (and in some cases the life of a second annuitant) with any remaining monies directed to a charity as designated by the CGA annuitant. (See, SOF A..1.; F.20.a.) While MAF brochures stated that MAF had current assets from which to pay the monies promised under the MAF CGA's, (see, SOF A.1.), in fact, the monthly annuity payments to later MAF Victims came from monies paid in by earlier Victims. (See, SOF A.2-3.)6 MAF's principle and nearly exclusive source of income was from the sale of MAF CGAs. (See, SOF A.2-3.) Most unfortunately, Dillie used the MAF monies for his

10 11 12 13 14 15 16 17 18 19 20 21 22 23

For ease of reference, citations typically will be made only to the UFTA and the Arizona statutes for discussions regarding the elements required to establish a fraudulent transfer claim or an affirmative defense to such claim. 6 The Defendants' commissions were also paid from the monies provided to MAF by MAF CGA Victims. (See, SOF A.3.d.)
Document 464

5

Case 2:03-cv-02390-JAT

5Filed 12/29/2005

Page 5 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

own personal benefit as reflected in his guilty plea to count 135 of the Indictment against him in U.S. v. Dillie, CR-03-115-PHX-DGC wherein Dillie admitted among other things that he caused to be transferred $350,000.00 from a MAFG bank account to Caesar's Palace Casino in Las Vegas, Nevada to pay for his gambling debts. (See, SOF A.9., ¶11.d. of plea agreement.) Because Dillie was using the monies paid by later Victims as the source of income to support the promised monthly annuity payments on earlier-issued MAF CGAs, every MAF CGA sold caused MAF to sink further into insolvency. (See, SOF A.2-5.) Thus, this classic Ponzi scheme was bound to collapse. True to form, the scheme came to an end when Dillie sent a letter to the MAF Victims on October 12, 2001 informing them for the first time that Mid-America was insolvent. (See, SOF A.7.) ( Naturally, Ponzi schemes are doomed to collapse when payments to those at the top of the pyramid scheme outpace the new Victim funds being brought into the scheme.) Subsequently, the Securities and Exchange Commission filed suit in the United States District Court for the District of Arizona and requested that the Court appoint a Receiver to recover the assets of MAF and MAFG for ultimate distribution to the MAF CGA Victims. Meanwhile, Dillie was indicted in federal court on 193 counts relating to his operation of the MAF CGA Ponzi scheme. (See, SOF A.8.) On October 31, 2005, Dillie pled guilty to three counts involving defrauding victims out of money related to the sale of MAF CGAs. (In his plea agreement, Dillie admitted that he was selling MAF CGAs which he knew would not be paid because of insufficient assets and that the monies paid by MAF annuitants were actually used to pay for such things as Dillie's

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

Document 464

6Filed 12/29/2005

Page 6 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

gambling debts.) (See, SOF A.9.) Sentencing is scheduled for January 30, 2006. (See SOF A.9.) B. The Receiver has Proven as a Matter of Law that the Payment of Commissions to Defendants with MAF Moneys was Done with the Actual Intent to Hinder, Delay, or Defraud Creditors. There is no dispute that transfers were made from MAF to the Defendants in the form of commission payments. (See, SOF, F.1.a.iv.; F.3.a.iv.; F.5.a.ii.; F.7.a.v.; F.9.a.i.F.; F.12.a.v.; F.12.b.vii.; F.15.a.xv.; F.17.a.v.; F.17.b.v.; F.17.c.vii.; F.17.d.v.; F.18.a.vi.) The fraudulent intent element of UFTA §4(a)(1) is established as a matter of law when the transfer is made in furtherance of a Ponzi scheme. (See, In re Agricultural Research and Technology Group, Inc., supra, 916 F.2d at 535 (9th Cir. 1990) ("the debtor's actual intent to hinder, delay or defraud its creditors may be inferred from the mere existence of a Ponzi scheme."); In re World Vision, 275 B.R. 641, 656 (Bankr. Fla. 2002) (holding that the fraudulent intent requirement in a fraudulent transfer claim will be inferred under bankruptcy and Florida fraudulent transfer laws where commissions made on the sale of fraudulent promissory notes underlying a Ponzi scheme were sought by a trustee: "In cases involving a Ponzi scheme, the analysis [regarding actual intent to hinder, delay, or defraud a creditor or prospective creditor] is simplified because fraudulent intent is inferred." Id., 275 B.R. at 656.7 The Court further explained:

10 11 12 13 14 15 16 17 18 19 20

The similarity between the elements of a fraudulent transfer claim under the bankruptcy fraudulent transfer statute (11 U.S.C. §548) and the one under the Uniform 22 Fraudulent Transfer Act is so close that a judicial interpretation of one is relevant to the interpretation of the other. (See, In re Randy, 189 B.R. 425, 443 (Bankr. 1995)). This 23 parallel includes the requirement of proving "good faith" in establishing the affirmative defense provided under 11 U.S.C. §548(c). Case 2:03-cv-02390-JAT Document 464 7Filed 12/29/2005 Page 7 of 38 21

7

1 2 3 4

A Ponzi scheme is by definition fraudulent. By extension, any acts taken in furtherance of the Ponzi scheme, such as paying brokers commissions, are also fraudulent. Every payment made by the debtor to keep the scheme on-going was made with the actual intent to hinder, delay or defraud creditors, primarily the new investors. Id., 275 B.R. at 656. See also, In re National Liquidators, Inc., 232 B.R. 915, 918

5 (Bankr. Ohio 1998) (holding that same inference of "fraudulent intent" is applicable to 6 claim of fraudulent transfer involving the payment of false profits to early investors in a 7 Ponzi scheme under bankruptcy law and the Ohio Uniform Fraudulent Transfer Act). 8 In addition, the fraudulent intent requirement of the fraudulent transfer claim also 9
Guttilla & Murphy, PC

is established as a matter of law by Dillie's admissions that he was selling MAF CGAs
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

10 which he knew would not be paid because of insufficient assets and that the monies paid 11 by MAF annuitants were actually used to pay for such things as Dillie's gambling debts 12 (see, SOF A.9.) (See, Scholes v. Lehmann, 56 F.3d 750, 761-762 (7th Cir. 1995), cert 13 denied. sub. nom, African Enter., Inc. v. Scholes, 516 U.S. 1028 (1995), holding that 14 fraudulent intent of transferor in Ponzi scheme established by way of guilty plea and plea 15 agreement in corresponding criminal case. Cf., In re Ramirez Rodriquez, supra, 209 B.R. 16 at 433 (Bankr. S.D. Tex. 1997) holding criminal conviction of transferor in criminal case 17 conclusively established fraudulent intent in fraudulent transfer claim in related civil 18 case; In re Randy, 189 B.R. 425, 439 (Bankr. Ill. 1995) holding that jury verdict in 19 20 21 22 23 It should be noted that unlike UFTA §8(a) (1984), the affirmative defense under 11 U.S.C. §548(c) requires proving "good faith" and that the transferee gave "value." In this case, the Defendants must prove that they acted in "good faith" and gave "reasonably equivalent value," which is a far more difficult task. Nevertheless, at least one Court has held that even under the lesser bankruptcy standard, "value is not given for commission payments in a Ponzi scheme. In re Randy, 189 B.R. 425, 443 (Bankr. 1995). See also, In re Ramirez Rodriquez, 209 B.R. 424 (Bankr. Tex. 1997).
Document 464

Case 2:03-cv-02390-JAT

8Filed 12/29/2005

Page 8 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

criminal proceeding regarding Ponzi scheme proved intent element in fraudulent transfer claim in corresponding civil case). Accordingly, summary judgment on the Receiver's fraudulent transfer claim should be granted based upon the undisputed facts proving the existence of a Ponzi scheme and damages should be awarded to the Receiver in the amount of commissions paid to each Defendant as follows: Bidwell ($23,682.71) (see, SOF, F.3.a.iv.); Bestgens ($104,248.32) (see, SOF, F.17.a.iii.); Carroll ($83,526.56) (see, SOF, F.1.a.iii.); Crosswells ($71,137.91) (see, SOF, F.17.b.iv.); Davis ($199,367.36) (see, SOF, F.18.a.v.); Derk ($44,850.61) (see, SOF, F.7.a.iv.); Frazier ($40,234.91 (see, SOF, F.12.a.iv.); Kerher ($33,038.55) (see, SOF, F.12.b.vi.); Lankford ($456,108.31) (see, SOF, F.15.a.xiv.); Radas ($39,111.01) (see, SOF, F.17.c.vi.); Richard ($143,866.94) (see, SOF, F.9.a.i.F.); and, Wehrly ($71,106.11) (see, SOF, F.15.d.v.), plus pre and post judgment interest. (See, Lapaz County v. Yuma, 153 Ariz. 162, 735 P.2d 772 (Ariz. 1987) holding that prejudgment interest on liquidated claims is a matter of right; A.R.S. § 12-347 (providing for post judgment interest)). VI. The Affirmative Defense of "Good Faith" Asserted by Defendants Fails Given the Undisputed Facts of this Case. UFTA offers a narrow and specific affirmative defense to a claim of actual fraud

10 11 12 13 14 15 16 17 18

under UFTA §8(a) (1984). (See, corollary state statues identical to UFTA §8(a) (1984) at 19 20 §726.109(1) (1990); 740 Ill. Comp. Stat Ann. §160/9(a) (West 1990); 14 Maine Rev. Stat. 21 Ann. §3579(1) (West 1985); Mass. Gen. L. Ann. 109A §9(a) (West 996); S.D. Codified 22 23
8

A.R.S. §44-1008(A) (1990); Cal. Civ. Code §3439.08(a) (West 1987)8; Fla. Stat. Ann.

Amendments made to Cal. Civ. Code §3439.08 in 1999 are not pertinent to this motion.
Document 464

Case 2:03-cv-02390-JAT

9Filed 12/29/2005

Page 9 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Laws §54-8A-8(a) (1987); Vernon's Tex. Stat. and Codes Ann., Business and Commerce Code, §24.009(a) (West 1993); and West's Rev. Code of Wash. Ann., Business Regulations, §19.40.081(a) (West 1987)9 However, the defense is unavailable to the Defendants. The applicable statutes provide that a fraudulent transfer (through actual fraud) is not voidable against "a person who took in good faith and for a reasonably equivalent value . . . ."10 (Emphasis added.) For purposes of Plaintiff's motion only, Plaintiff is not contesting the Defendants' assertion that they gave "reasonably equivalent value" in comparison to their commission payments, but is only contesting whether Defendants acted in "good faith". As earlier discussed, the burden is on the Defendants to prove they took their commissions in "good faith." Although the Plaintiff is not required to disprove an affirmative defense, the "good faith" issue is discussed briefly below.

10 11 12 13 14 15 16 17 18 19 20 21 22 23

A 2001 amendment to Wash. Rev. Code §19.40.081 did not substantively change §19.40.081(a). In order to prevail on their defense to the Receiver's fraudulent transfer claim, the Defendants would have to prove both that they took their commissions in "good faith" and that the Defendants' services equated to reasonably equivalent value when compared to the commissions paid to the Defendants. If the "good faith" element cannot be proven by Defendants, the entire defense falls. (See, UFTA §8(a) (1984); A.R.S. §44-1008(A) (1990).) Plaintiff's position is that services provided in selling a fraudulent investment such as the MAF CGAs, especially where each CGA sold further deepened the financial insolvency of MAF, is not of "reasonably equivalent value" to the commissions paid to the Defendants, as that phrase is used in UFTA §8(a) (1984); A.R.S. §44-1008(A); or, in A.R.S. §44-1004(A)(2). Moreover, since legitimate CGAs are sold without the payment of any commissions, the sale of the MAF CGAs for a commission cannot constitute reasonably equivalent value.
Document 464
10

9

Case 2:03-cv-02390-JAT

10 Filed 12/29/2005

Page 10 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

A. The Defendants Failure to Review an Audited Financial Statement for MAF before Selling its CGAs Precludes a "Good Faith" Defense to Protect the Defendants' Commissions. It is not possible to give a precise definition to the phrase "good faith" as used in the affirmative defense to a fraudulent transfer claim because it is fact dependent: At least one court has held that if the circumstances would place a reasonable person on inquiry of a debtor's fraudulent purpose, and a diligent inquiry would have discovered the fraudulent purpose, the transfer is fraudulent. (Emphasis in the original.) In re Agricultural Research and Technology Group, Inc., supra, 916 F.2d at 536. See also, Hall v. World Savings and Loan Assoc., 189 Ariz. 495, 943 P.2d 855 (Ariz. App. 1997). The Court in In re Cohen, 199 B.R. 709, 719 (BAP 9th Cir. 1996) held: One lacks the good faith that is essential to the UFTA §8(a) defense to avoidability if possessed of enough knowledge of the actual facts to induce a reasonable person to inquire further about the transaction. UFTA §8(a), comment (2) (knowing facts rendering transfer voidable `would be inconsistent with the good faith that is required of a protected transferee'). Such inquiry notice suffices on the rationale that some facts suggest the presence of others to which a transferee may not safely turn a blind eye. In the instant case, what circumstances would place a reasonable person on inquiry notice are even more sensitive than would be for a lay person because here the Defendants are all licensed to sell financial products and as such knew, or certainly should have known, that they had a duty or obligation to investigate products before selling them to a public which can reasonably be expected to put its trust in the "expertise" (as reflected by their license) of the agent. Here, licensed insurance agents
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

11 Filed 12/29/2005

Page 11 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

received transfers (i.e., commission payments) from MAF after selling the fraudulent MAF CGAs without having first asked those basic, preliminary questions expected of such licensees to verify the legitimacy of the MAF CGAs and, thus, the transfer itself. A recent Ponzi scheme case sheds insight into what is expected of an agent or broker selling a financial investment product in order to qualify as a "good faith" transferee under the Uniform Fraudulent Transfer Act. In In re World Vision Entertainment, Inc., 275 B.R. 641 (Bankr. 2002), a Ponzi scheme landed into bankruptcy. There, fraudulent nine-month promissory notes with annualized interest rates were sold by a network of brokers, mainly insurance agents, who were paid commissions. The bankruptcy trustee brought a fraudulent transfer claim against the brokers for the return of commissions earned by bringing victims into the Ponzi scheme. The Court summarized the way in which a court will determine whether a "good faith" defense is established: Courts will determine whether the good faith defense is established by looking at the actions and knowledge, both actual knowledge and imputed knowledge, of the recipient. Some recipients, such as insiders directly running the Ponzi scheme, obviously could not demonstrate good faith because of their involvement in the enterprise and their actual knowledge of the fraud. Other recipients, such as third party vendors and landlords, probably can demonstrate good faith with relative ease. The Court continued: The issues raised in this adversary proceeding present a middle ground, a third type of recipient--brokers who sell the debt instruments that allow a Ponzi scheme to continue. The broker's sole job is to sell these fraudulent notes or mortgages to investors. The brokers often have long-term relationships with their clients. The clients usually are elderly and financially unsophisticated. The clients rely on the
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

12 Filed 12/29/2005

Page 12 of 38

1 2 3 4

brokers for financial advice. Therefore, the issue is whether these brokers act in good faith if they make no or little effort to verify the legitimacy of the debt instruments they market. Stated differently, can a broker simply rely on promises made by a dishonest and fraudulent debtor and still act in good faith? * * *

5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

`[C]ourts look to what the transferee objectively `knew or should have known' rather than examining what the transferee actually knew from a subjective standpoint.' In re Agricultural Research & Technology Group, Inc., 916 Fl. 2d 528, 535-56 (9th Cir. 1990). `[I]f the circumstances would place a reasonable person on inquiry of a debtor's fraudulent purpose, and diligent inquiry would have discovered the fraudulent purpose, then the transfer is fraudulent.' (Citation omitted.) (Emphasis in the original). * * * Finding that an objective standard is appropriate to use in judging good faith, the Court first must define the steps a prudent broker acting in good faith would take before selling the debtor's notes. Then, the Court must determine if the defendants took these steps.

10 11 12 13 14 ld., 275 B.R. at 658-659. 15 As excerpted, an important question posed to the Court in In re World Vision 16 Entertainment was: "can a broker simply rely on promises made by a dishonest and 17 fraudulent debtor and still act in good faith?" In In re World Vision Entertainment, Inc., 18 supra, 275 B.R. at 659. The Court's unequivocal answer was "no." The Court held that 19 before selling the financial investment products, a broker must first request and review 20 "with a critical eye audited financial statements of the company" (emphasis added) 21 issuing the promissory notes and the broker "cannot rely only on slick, marketing 22 brochures or insurance coverage, refrain from asking hard questions about the legitimacy 23
Case 2:03-cv-02390-JAT Document 464

13 Filed 12/29/2005

Page 13 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

of the product" before he can prove a "good faith" defense. In re World Vision Entertainment, Inc., supra, 275 B.R. at 660. This standard has equal application to the sale of MAF CGAs which, just like the notes in In re World Vision Entertainment, Inc., were targeted at consumers (often elderly) as a means of obtaining a source of income. Ultimately, the Court held that the broker-defendants who sold the fraudulent short-term promissory notes could not retain their commissions under the protection of a "good faith" defense to a fraudulent transfer claim where the brokers had failed to review available investment ratings from qualified financial rating services, had failed to review with a critical eye audited financial statements of the company issuing the notes, and had failed to check the background of key employees of the Ponzi operation. See also, In re Evergreen Security, Ltd., 2003 WL 23975405 (Bankr. Fla. 2003) granting judgment to a trustee and holding that a group of lawyers, brokers, investment advisors and insurance agents who sold investment certificates that turned out to be part of a Ponzi scheme did not have a "good faith" defense to a trustee's fraudulent transfer claim aimed at the group's commissions where the defendants failed to review available investment ratings from qualified financial rating services, failed to obtain audited financial statements from the issuer of the certificates and, failed to investigate the background of key employees of the issuer before selling the certificates to the public. In the instant case, the Receiver has retained Mr. Vincent Micciche as an expert witness to testify what steps the Defendants were obligated to take under industry standards before selling the MAF CGAs. Mr. Micciche has trained and supervised people who were licensed to sell insurance and/or securities for the past twenty-three years and has trained people in regulatory compliance matters relating to the sale of
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

14 Filed 12/29/2005

Page 14 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

securities and insurance. (See, SOF 26(a)-(b).) Among a list of steps that Defendants should have taken as a basic investigation of the MAF CGAs (as found at page seven of Mr. Micciche's expert report), one of the most important was to obtain an audited financial statement for MAF for the past three years. (See, SOF 26(b).) It doesn't take much analysis to conclude why an audited financial statement is so important: it is the only way to verify the actual financial state of a company. This is obviously particularly important where the product offered by the company is financial. Without an audited financial statement, the Defendants had nothing but the empty words of the MAF representatives upon which to rely in assessing the financial soundness of MAF. Even the Defendants were aware of how critical it was to See obtain an audited financial statement from MAF because some asked for one. (See, SOF, F.12.b.viii ­ix; F.15.a.3-4, 7-8; F.17.a.vi; F.18.a.xiv.) For example, when asked whether he had ever requested a financial statement for MAF or MAFG prepared by an independent certified public accountant, Defendant Kerher answered: Defendant made requests for an audited financial statement in 1998. He received information from marketing people in the MAF office (Tom Bishop) and legal representatives (Sara Vanucci and Felicia Majewski). Those unaudited `summary Profit and Loss' statements were received in approximately 1999 and have previously been disclosed. Defendant requested Audited Financial Statements numerous times in 1999. When he did not receive an Audited Financial Statement, despite the fact that Defendant was told a Big Ten accounting firm was working on it, Defendant no longer solicited CGA sales. All sales by Defendant were completed in 1999. (Emphasis added.) (See, SOF, F.12.b.viii.)

10 11 12 13 14 15 16 17 18 19 20 21

When asked why Defendant Ronald Kerher requested audited financial statements 22 from MAF or MAFG as referenced in his response to Receiver's Interrogatory no. 29, 23
Case 2:03-cv-02390-JAT Document 464

15 Filed 12/29/2005

Page 15 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Defendant Kerher responded: "Defendant believed it to be prudent and reasonable to request audited financial statements." (See, SOF, F.12.b.x.) During questioning regarding a request for an audited financial statement from MAF, Defendant Kerher answered "yes" when asked: "Would it be fair to say that you, that the [Mid-America] Foundation would be required to make payments to your clients, and you wanted to ensure that it was financially sound, that Mid-America was financially sound?" (See, SOF, F.12.b.xii.) Obviously, the time to ensure the financial soundness of MAF would have been prior to selling its CGAs. Defendant Lankford testified that he "wanted to see audited financial statements that would show . . . [him] that . . . [his] clients' money was safe." An audited financial statement would have shown "[w]ell, it would have come from an auditing group whether KPMG or any of the other big ones. And it would have shown me the audited returns, the physical returns audited and certified by that accounting group. So . . . [I] would know what they were--what their financial position was." (See, SOF, F.15.b.i.) Defendant Lankford also testified that without an audited statement there was no one who could confirm the numbers of dollars MAF stated it had in reserves to cover its charitable gift annuity obligations. Defendant Lankford testified, "That's why I was screaming for an audited financial statement." (See, SOF, F.15.b.ii.) The significance of the failure to receive financial statements when demanded is also exemplified by the Defendants themselves: When asked to explain why Defendant Kerher's failure to receive audited financial statements from MAF was so significant that it caused him to stop selling MAF CGAs, Defendant Kerher responded: "Any company Defendant requests something from that does not provide the information or
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

16 Filed 12/29/2005

Page 16 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

documentation would make Defendant consider looking elsewhere." (See, SOF, F.12.b.xi.) Defendant Lankford testified that after he had almost stopped selling MidAmerica Foundation, Inc. CGAs, he was "very adamant that . . . [he] wanted to see audited financial statements because 18 months had gone by and I hadn't seen any." (Emphasis added.) (See, SOF, F.15.c.vi.) Defendant Lankford also testified under oath that in late 1999, after he sold the MAF CGAs, except for CGA numbers 20772 and 20922, he gave an "ultimatum, that if . . . [he] didn't have [Mid-America Foundation] audited financial statements by that time, . . . [he] would start whatever proceedings that . . . [he] had to, to get this in front of the regulators." (See, SOF, F.15.c.vii.) Indeed, had Defendant Lankford put action behind his threats to turn MAF over to the regulators back in late 1999, numerous Victims involved in this case might have been spared. It is undisputed that every single Defendant failed to obtain an audited financial statement before selling the MAF CGAs. What is more astounding is that some Defendants actually asked for one, did not obtain it, and yet continued to sell the MAF CGAs, i.e., Bestgen (SOF, F.17.a.iv.; F.17.a.vi.); Kerher (SOF, F.12.b.vi; F.12.b.viii.); and Lankford (SOF, F.15.a.xiv, CGA Nos. 20772, 20992; F.15.c.iv-viii.) Although the

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Receiver's expert witness makes it clear that one of the most important steps that Defendants should have taken was obtaining an audited financial statement before selling the MAF CGAs (see SOF 26(b)), the Defendants themselves make it likewise clear through their demands for the audited financial statement, particularly Defendant Lankford who testified that in late 1999 he gave an "ultimatum" that if he didn't get audited financial statements, he would "get this in front of the regulators". (SOF,
Document 464

Case 2:03-cv-02390-JAT

17 Filed 12/29/2005

Page 17 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

F.22.dd) (And yet, Defendant Lankford continued to sell two more MAF CGAs (SOF, F.22.ee.).) For all Defendants, whether they chose to not request an audited financial statement or proceeded to sell the MAF CGAs despite having their requests go unfulfilled, the assertion of selling the MAF CGAs in "good faith" is akin to someone claiming that after they put a blindfold over their own eyes, they couldn't tell if the room they were in was on fire. Under the undisputed facts, the Defendants' advancement of a "good faith" defense is at best meritless and, at worse, is utterly disingenuous. B. All Defendants Sold Securities that Involved a Violation of Security Laws. The Securities Exchange Act of 1934 (see, 15 U.S.C. §78o (1996-2001)) requires persons who are engaged in the business of effecting transactions in securities for the account of others, i.e., "brokers," and persons engaged in the business of buying and selling securities for his own account, through a broker, or otherwise i.e., "dealers," to be registered to sell securities. (See,§§ 15 U.S.C. --78c-3(a)(4)& (5) (1996-2001).) The MAF CGAs are "securities" because they are investment contracts. An investment contract is a scheme which "involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Securities and Exchange Commission v. W. J. Howey, Co., 328 U.S. 293, 301 (1946). Here, it is undisputed fact that MAF Victims paid money to MAF. In exchange, all funds paid to MAF were to be pooled and each annuitant was promised (under his or her CGA contract) a monthly rate of return on his or her investment. Last, MAF was to manage and invest the funds provided by the Victims. Accordingly, the MAF CGAs fit the definition of a security under Howey. See also, expert report of Mr. Spencer C. Barasch
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

18 Filed 12/29/2005

Page 18 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

of the international law firm Andrews Kurth opining that the MAF CGAs are securities. (Mr. Barasch served as an Associate Director of the SEC's Forth Worth Office [in the enforcement program covering Texas, Okalahoma, Kansas and Arkansas] and as an Assistant Director, Trial Counsel Branch Chief and Staff Attorney from 1987-April 2005). (See SOF 26.d.) Neither MAF nor MAFG were registered as a broker-dealer. (See, SOF, 27.a.) However, there is an exception to the broker-dealer registration requirement found in the Philanthropy Protection Act of 1995 (the "PPA"). The Philanthropy Protection Act of 1995 (the "PPA") was enacted to protect and facilitate donations to charitable organizations11 by limiting the applicability of federal and state securities laws. Congress implemented this protection by exempting such charitable organizations from registering under the Investment Company Act of 1940, exempting their securities from registration under the Securities Act of 1933 and the Securities and Exchange Act of 1934, and from registering under the Investment Advisers Act. Congress provided for such exemptions because many charitable organizations have charitable income funds12

10 11 12 13 14 15 16 17 18 19 20

Charitable organization is defined as "(a)ny company organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes--(i) no part of the net earnings of which inures to the benefit of any private shareholder or individual; or (ii) which is or maintains a fund described in subparagraph (B)." 15 U.S.C. § 80a-3(c)(10)(A).
12

11

The "fund" means "a pooled income fund, collective trust fund, collective investment 21 fund, or similar fund maintained by a charitable organization exclusively for the collective investment and reinvestment of one or more of the following: (i) assets of the 22 general endowment fund or other funds of one or more charitable organizations; (ii) assets of a pooled income fund; (iii) assets contributed to a charitable organization in 23 exchange for the issuance of charitable gift annuities; (iv) assets of a charitable remainder trust or of any other trust, the remainder interests of which are irrevocably dedicated to Case 2:03-cv-02390-JAT Document 464 19 Filed 12/29/2005 Page 19 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

which offer investment-type programs to donors. Charitable income funds include a variety of vehicles that permit donors to make contributions and retain a remainder interest, usually a lifetime income interest, in the donated property. Prior to 1995, the Securities and Exchange Commission had concluded that such charitable income programs were securities, but exempt from registration, provided that the charity adhered to certain requirements. As a result of a class action challenge to the exemption in 1995, Congress acted to codify the SEC's position. (See, House Report 104-333, Philanthropy Protection Act of 1995, pp. 4-9.) The PPA exempts charitable organizations from the registration requirements of the Investment Company Act (15 U.S.C. § 80a-3c(10)), the Securities Act of 1933 (15 U.S.C. § 77c(a)(4)), the Securities and Exchange Act of 1934 (15 U.S.C. § 78c(a)(12)(A)), and the Investment Advisers Act of 1940 (15 U.S.C. § 80b-3(b)). Under the securities laws, exemptions from registration requirements "are construed narrowly.

10 11 12 13 14 15 16 17 18 19 20 21 22 23

any charitable organization; (v) assets of a charitable lead trust; (vi) assets of a trust, the remainder interests of which are revocably dedicated to or for the benefit of 1 or more charitable organizations, if the ability to revoke the dedication is limited to circumstances involving-(I) an adverse change in the financial circumstances of a settlor or an income beneficiary of the trust; (II) a change in the identity of the charitable organization or organizations having the remainder interest, provided that the new beneficiary is also a charitable organization; or (III) both the changes described in subclauses (I) and (II); (vii) assets of a trust not described in clauses (i) through (v), the remainder interests of which are revocably dedicated to a charitable organization, subject to subparagraph (C); or (viii) such assets as the Commission may prescribe by rule, regulation, or order in accordance with section 6(c)." 15 U.S.C. § 80a-3(c)(10)(B).
Document 464

Case 2:03-cv-02390-JAT

20 Filed 12/29/2005

Page 20 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

The burden of proof is on the person who would claim such an exemption." Securities and Exchange Commission v. Blazon Corp., 609 F.2d 960, 968 (9th Cir. 1979); McDaniel v. Compania Minera Mar De Cortes, Inc., 528 F.Supp. 152, 160 (D. Arizona 1981); SEC v. Children's Hospital, 214 F. Supp. 883, 888 (D. Arizona 1963). MAF and MAFG fail to qualify for the exemption from the broker-dealer requirements of the Securities Exchange Act of 1934 provided via the PPA. (See, 15 U.S.C. § 78c(e) (1996-2001).) The PPA exempts charitable organizations, officers, directors, employees and volunteers13 from registering as broker-dealers for transactions involving income funds provided the persons soliciting donations "is either a volunteer or is engaged in the overall fund raising activities of a charitable organization and receives no commission or other special compensation based on the number or the value of donations collected for the fund." (See, 15 U.S.C. § 78c(e)(2).) In this case, it is undisputed that each Defendant earned commissions that were directly related to the number and value of "donations collected for the fund". (See, SOF F.23.) Therefore, neither MAF nor the Defendants themselves, were exempt from the registration

10 11 12 13 14 15 16 17 18 19 20 21 22 23

To understand the policy behind these provision, reference can be made to the House Report on the PPA, which discusses the circumstances under which registration had not been required by the SEC included that "any person soliciting contribution to the fund is either a volunteer or is employed in the charity's overall fundraising activities is and is not compensated on the basis of the amount of gifts transferred to the fund." House Report 104-333, p. 7. The SEC viewed "receipt of transaction-based compensation as potentially providing the incentive to persons who work for charitable organizations to engage in high-pressure or abusive sales practices." House Report 104-333, p. 7, n. 4. The foregoing shows the limited scope of the exemption to organizations that use their employees or uncompensated volunteers to sell CGAs. The exemption is unavailable once the organization engages others to sell CGAs who are compensated based on the amount of the gifts transferred to the fund.
Document 464

13

Case 2:03-cv-02390-JAT

21 Filed 12/29/2005

Page 21 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

requirements of the Securities and Exchange Act of 1934. Accordingly, all Defendants sold securities that involved a violation of the federal securities laws, i.e., the failure of MAF to be registered as a broker-dealer to legally sell the CGAs. Additionally the Defendants themselves, as individuals, were required to be licensed as brokers or dealers to sell the CGAs. Only Defendants Derk, Frazier and Kerher identified themselves as holding security licenses. (See, SOF, F.7.a.i; F.12.a.i.; F.12.b.ii; F.24.) All other defendants were unlicensed to sell securities thereby violating not only federal security law but also individual state laws requiring licensing of brokerdealers, i.e., Defendants Bestgen, Rada, Crosswell and Wehrly violated A.R.S.§44-1842 (1978); A.R.S.§44-1841(9) (1978); Defendant Carroll violated Cal. Corp. Code §25210 (West 1979 & 1998); Cal. Corp. Code §25004 (West 1974;) Defendant Bidwell violated West's Rev. Code of Wash. Ann., Securities, §21.20.040 (1998); West's Rev. Code of Wash. Ann., Securities, §21.20.005 (1998) and 815 Ill Comp. Stat. Annot. § 5/8 (West 1998); 815 Ill Comp. Stat. Annot. § 5/8-102(a)(3)(1996); Defendant Richard violated 32 Maine Rev. Stat. Ann. §10301 (1999); Defendant Lankford violated Vernon's Texas Code Ann., Securities, §581-12 (1995); Vernon's Texas Code Ann., Bus. & Commerce Code,§8.102 (1995)); Defendant Davis violated Mass. Gen. Laws Ann. 110A §201 (West 1993); Mass. Gen. Laws Ann. 110A §401 (West 1993). (See, SOF, F. 24.) C. The Sale of MAF CGAs in California, Florida, Illinois, South Dakota, Texas and Washington Violated State Laws. In addition to the foregoing federal law violations, the sale of MAF CGAs violated the laws regulating the sales of CGAs in California, Washington, Illinois, Florida, Maine, South Dakota and Texas.
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

22 Filed 12/29/2005

Page 22 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

1. The Sale of MAF CGAs in California by Defendant Carroll Violated California State Law. As set forth in detail in the accompanying Receiver's Statement of Facts, Defendant Carroll sold MAF CGAs to Victims in California. Defendant Carroll stated that he has been a California-licensed insurance agent since 1991. (See, SOF, F.1.a.i). Defendant Carroll sold MAF CGAs in October 1997 and June 2000. (See, SOF, F.1.a.iii.) These sales violated numerous California laws. First, California regulates the sale of annuities in its state. Annuities may be sold in California by an insurer whose admission has been secured by procuring a certificate of authority from the Commissioner of the California Department of Insurance. (See, Cal. Ins. Code §700(a) (West 1991); §101 (West 1935)). The scrutiny involved in the issuance of a certificate of authority is aimed at protecting the public. (See e.g., Cal. Civ. Code §10489.2 (West 1997) involving valuations of policies and contracts and Cal. Ins. Code §730 (West 1992) involving examinations of insurers to verify their solvency.)14 MAF is a charitable organization not an insurer. MAF was never authorized to sell insurance/annuities in California as an insurer. (See, SOF, F.2.)

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Under California law, all agents engaged in the transaction of insurance owe a prospective insured who is age 65 or older, a duty of honesty, good faith, and fair dealing. Cal. Ins. Code §785(a) (West 1996). (Defendant Carroll's clients were in their 80s. (See, SOF, F.1.a.iii.) Also under California law, when annuities were sold to seniors (defined as those 60 years or older) the policies were to include specific information regarding cancellation rights which was not present in the CGA policies sold by Defendant Carroll. See, Cal. Ins. Code §10127.10 (West 1994). (See, SOF, F.1.a.iii; CGA policies marked as Exhibits 19 and 20).
Document 464

14

Case 2:03-cv-02390-JAT

23 Filed 12/29/2005

Page 23 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Charitable organizations may sell CGAs in California as a grants and annuity society if they obtain a certificate of authority to do so. Such certificates may be issued if the charitable organization has been in active operation for at least 10 years (subject to exceptions not pertinent to this case). (See, Cal. Ins. Code §11520 (West 1995); Cal. Ins. Code §11520.5 (West 1985); Cal. Ins. Code §11520.6 (West 1993). After the issuance of such a certificate, the charitable organization is required to establish and maintain a reserve fund adequate to meet future payments under its outstanding annuity contracts (see, Cal. Ins. Code §11521 (West 1949)) as well as establish a trust agreement for reserves held for the benefit of California annuitants (see, Cal. Ins. Code §11521.1 (West 1993)). Before granting a certificate of authority, California considers the minimum net worth and working capital of the charitable organization, the lawfulness and quality of its investments, its financial stability, its reinsurance agreements, the competency, character and integrity of management, its ownership and control, its fairness and honesty of methods of doing business, and the risk to the public. See, Cal. Ins. Code §11520.6 (West 1993). See, also, Cal. Ins. Code §11520.5 (West 1985);Cal. Ins. Code §11521.2 (West 1978); Cal. Ins. Code §11521.3 (West 1993); Cal. Ins. Code §11522 (West 1984); and Cal. Ins. Code §11523 (West 1949) regarding underlying requirement for certificates of authority. None of the state requirements that help ensure the legitimacy and financial soundness of a CGA were present here. MAF had not been in operation for at least ten years and it was insolvent at the time Defendant Carroll sold its CGAs. Most importantly, MAF never obtained any certificate of authority to sell annuities from the
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

24 Filed 12/29/2005

Page 24 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Commissioner of the California Department of Insurance. (See, SOF, F.2.a.) Accordingly, Defendant Carroll sold MAF CGAs that were not authorized for sale in the state of California. 2. Defendant Bidwell's Sale of MAF CGAs in Washington and Illinois Violated Those States' Insurance Statutes. a. Washington Defendant Bidwell stated that he held an insurance license since 1978 although he did not identify the state issuing the license. (See, SOF, F.3.a.i.) Records from the State of Washington indicate he was licensed to sell life and disability insurance in the State of Washington from June 11, 1997 to June 11, 2001. (See, SOF, F.3.a.i.) Defendant Bidwell sold MAF CGAs in Washington in 1999 to 83 and 62 year old Victims. (See, SOF, F.3.a.iv.) These sales violated numerous Washington laws. Like California, Washington regulates the sale of annuities. Annuities may be sold in Washington if their admission has been procured by an insurer through the issuance of a certificate of authority from the State of Washington Office of Insurance Commissioner. See, West's Rev. Code of Wash. Ann., Insurance, §48.05.030 (1947); West's Rev. Code of Wash. Ann., Insurance, §48.05.070 (1947); West's Rev. Code of Wash. Ann., Insurance, §48.11.020 (1947). MAF is a charitable organization not an insurer. MAF was never authorized as an insurer to sell annuities in Washington. (See, SOF, F.4.a.) Certificates of exemption, however, will be issued to charitable institutions conducting a charitable gift annuity business where certain qualifications are met. Among the qualifications are the following: the charitable organization must have and maintain minimum unrestricted net assets of five hundred thousand dollars meaning the
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

25 Filed 12/29/2005

Page 25 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

excess of total assets over total liabilities that are neither permanently restricted nor temporarily restricted by donor-imposed stipulations; it must file an annual statement including certain financial information with the Washington Insurance Commissioner on an annual basis; and, that it must attach to the first page of its annual statement the statement of a qualified actuary setting forth his opinion relating to annuity reserves and other actuarial items. See, West's Rev. Code of Wash. Ann., Insurance §48.38.010 (1998); West's Rev. Code of Wash. Ann., Insurance §48-38-012 (1998); West's Rev. Code of Wash. Ann., Insurance §48.38.020 (1998). Upon receiving a certificate of exemption, the charitable organization is to maintain a separate reserve fund adequate to meet its future annuity payments. See, West's Rev. Code of Wash. Ann., Insurance §48.38.020 (1998). Of course, MAF was never issued a certificate of authority or a certificate of exemption to sell charitable gift annuities in the state of Washington. (See, SOF, F.4.a.) How simple it would have been for Defendant Bidwell to discover that the sale of MAF CGAs to Washington residents in Washington was illegal by requesting a copy of the certificate of exemption for MAF before agreeing to sell the MAF CGAs. b. Any Sale of MAF CGAs in Illinois Violated the Laws of that State. In 1999, Defendant Bidwell sold a MAF CGA to a 71 and 73 year old Illinois couple. (See, SOF, F.5.a.) If Defendant Bidwell takes the position that he sold this CGA in Illinois rather than Washington, the sale of the CGA still violated state law. Annuities may be sold in Illinois by a business that has been issued a certificate of authority from the Director of the State of Illinois Department of Financial and Professional Regulation, Division of Insurance. (See, 215 Ill Comp. Stat. Annot. §5/24 (West 1957); 215 Ill Comp.

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

Document 464

26 Filed 12/29/2005

Page 26 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Stat. Annot. § 5/4 (West 1999)). MAF did not have a certificate of authority to sell annuities in the state of Illinois. (See, SOF, F.6.a.)15 Under 215 Ill Comp. Stat. Annot.§ 5/121-2.10 (West 1996), charitable gift annuities are exempt from the Illinois insurance laws where an insurer authorized to transact business in Illinois is directly obligated to the annuitant (not applicable here as evidenced in SOF, F.6.a.) or the charitable organization had been in active operation for not less than 20 years before the date of the issuance of the annuity and the charity had an unrestricted fund balance of not less than $2,000,000.00 on the date the annuity was issued. None of these requirements were met by MAF who issued the CGA. There can be no legitimate dispute that MAF had not been in operation for twenty years at the time of the sale of the MAF CGA and MAF (see, SOF B.1.) and MAF was insolvent on the day the MAF CGA was issued. (See SOF, A.3-5.) In this particular case, if Defendant Bidwell takes the position that he sold the cga in issue in Illinois, then he also participated in the direct violation of one more state law: He did not have a license to sell insurance in the State of Illinois when he sold the fraudulent MAF CGA. (See, SOF, F.6.a.) . . . . . . . . .

10 11 12 13 14 15 16 17 18 19 20

MAFG had a license as a "registered firm" with the Illinois Dept. of Insurance from March 2, 1999-March 14, 2003 but did not have authority to "arrange any specific type of 22 coverage." (See, 215 Ill. Comp. Stat. Ann. §5/24 (West 1957) which states: "No company shall transact any business of insurance until it has received a certificate of authority as 23 herein prescribed nor any business of insurance not specified in such certificate of authority." (See, SOF, F.6.a.) Case 2:03-cv-02390-JAT Document 464 27 Filed 12/29/2005 Page 27 of 38 21

15

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

3. The Sale of MAF CGAs by Defendant Derk in Florida Violated that State's Insurance Statutes. There is no dispute that Defendant Derk sold two MAF CGAs in 2000 to annuitants who were 54 and 73 years old at the time. (See, SOF, F.7.a.iv.) The sale of annuities in Florida is regulated through the Florida Office of Insurance Regulation. Only insurers who have been authorized to sell annuities in Florida may do so legally. (See 215 Ill Comp. Stat. Annot. § 5/4 (West 1999) Fla. Stat. Ann §624.401(West 1991). MAF was not authorized as an insurer to sell annuities in Fla. (See, SOF, F.8.a.) There is an exception to Florida's regulation of annuities for those charitable gift annuities that meet the requirements of Fla. Stat. Ann. §627.481(West 1999) including: the charitable organization must have been in active operation for at least five years prior to the sale of the CGAs and the charitable organization must have had and maintained admitted assets at least equal to the sum of the reserves on its outstanding annuity agreements, calculated in accordance with a specific I.R.S. code section and the charitable organization must maintain a surplus of 25% of such reserves. In addition, specified assets were to be segregated from other funds of the organization. (See, Fla. Stat. Ann. §627.481(2) (West 1999)). MAF was not even incorporated until 1997 (see, SOF, B.1.); it was insolvent at the time Defendant Derk sold the MAF CGAs (see, SOF, B.3); despite this, Defendant Derk proceeded to sell the MAF CGAs. . . . . . . . . .
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

28 Filed 12/29/2005

Page 28 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

4. The Sale of MAF CGAs by Defendants Frazier and Kerher in South Dakota Violated that State's Insurance Statutes. There is no dispute that Defendants Frazier and Kerher sold MAF CGAs between 1998 and 2001. (See, SOF, F.12.a.iv-v.; F.12.b.vi-vii.) The Victims to whom the MAF CGAs were sold were all in their 80's. (See, SOF, F.12.a.iv; F.12.b.vi.) Defendant Frazier stated that he held a South Dakota life and health insurance license since 1995 (see, SOF, F.12.a.i.) and Defendant Kerher stated that he held a life and health insurance license from South Dakota since 1982. (See, SOF, F.12.b.i.) The sale of annuities in South Dakota is regulated by the South Dakota Department of Revenue & Regulation, Division of Insurance. (See, S.D. Codified Laws §58-6-20 (1966)). Only insurers authorized by the State of South Dakota to sell annuities in that state may do so legally. (See, S.D. Codified Laws §58-6-1 (1978); S.D. Codified Laws §58-6-1(2001) (regarding the 2001 MAF CGA sold the E.L. Lucklam).) MAF was not licensed to sell annuities in South Dakota. (See, SOF, F.13.a.)16 The sale of charitable gift annuities was exempt from insurance regulation under certain, specific conditions. In 1998, at the time of the sale of the MAF CGAs to E.L. Lucklam, the Mortensons, I. Mehlhaff and V. Park, charitable gift annuities could only lawfully be sold by qualified organizations that were domiciled in South Dakota and had their principal place of business in South Dakota. (See, S.D. Codified Laws §58-1-16

10 11 12 13 14 15 16 17 18 19 20 21

MAFG was authorized to sell life and health insurance in South Dakota from 6/11/01 22 through 12/31/02. (See, SOF, F.13.a, Exhibit 70.) However, the CGAs sold by Defendants Frazier and Kerher were issued by MAF. (See SOF, F.12.a.iv, Exhibits 6023 62; F.12.b.vi, Exhibits 64-65.) Further two of the three MAF CGAs sold by the Defendants were sold in 1998. (See, Id.) Case 2:03-cv-02390-JAT Document 464 29 Filed 12/29/2005 Page 29 of 38

16

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

(1994)). As earlier discussed, supra, MAF was domiciled in Delaware and operated out of Arizona. In 2001, at the time of the sale of the MAF CGA to E. L. Lucklam (again), charitable gift annuities could only be sold lawfully in South Dakota if, among other things, the qualified organization had operated for a period of ten years and had a minimum of five hundred thousand dollars in unrestricted cash, cash equivalents or publicly traded securities, exclusive of the assets funding the annuity agreements as of the date of the annuity agreements. (See, S.D. Codified Laws §58-1-16 (2001).) At the time of the sales of the MAF CGAs, MAF had only been incorporated since 1997 (see, SOF, B.1.) and was insolvent (see, SOF, A.3-5.). Clearly, these sales violated South Dakota law. 5. The Sale of MAF CGAs by Defendant Lankford was in Violation of Texas Law. Defendant Lankford testified that he held a Life/Health insurance license from the State of Texas since 1997. (See, SOF, F.15.a.i.) Between 1998 and 1999, Defendant Lankford sold 29 MAF CGAs to persons in Texas ranging from 52 to 88 years of age; most were in their 70's and 80's. (See, SOF, F.15.a. xiv-xv.) The sale of annuities in Texas is regulated by the Texas Department of Insurance. (See, Vernon's Tex Code Ann., Insurance Code, §1.14-1 (West 1995) (prior to September 1, 1999), and Vernon's Tex Code Ann., Insurance Code §§21.01; 3.57 (West 1999) (on or after September 1, 1999).) MAF was not authorized to sell insurance in the State of Texas. (See, SOF, F.16.a.)

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

Document 464

30 Filed 12/29/2005

Page 30 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

Qualified charitable gift annuities were exempt from regulation if they met certain criteria. The same basic requirements for the sale of lawful CGAs in Texas, at all times pertinent, included the following: no charitable gift annuities were to be sold in Texas unless the charitable organization issuing the CGAs had a minimum of $100,000 in unrestricted cash, cash equivalents, or publicly traded securities, exclusive of the assets funding the annuity agreement as of the date of the annuity agreement. Additionally, the charitable organization was to have been in continuous operation for at least three years. See, Vernon's Tex Code Ann., Insurance Code, §1.14-1A, Sec. 1(3)(A)-(B) (West 1995); Vernon's Tex Code Ann., Insurance Code, §102-001- 002. (West Sept. 1999). Further, the CGA agreement was to state, in writing, that a qualified charitable gift annuity was not insurance under the laws of Texas and was not subject to regulation by the Texas Insurance Department or protected by a guaranty association affiliated with the Department of Insurance. See, Vernon's Tex Code Ann., Insurance Code, §1.14-1A, Sec. 3(a) (West 1995); Vernon's Tex Code Ann., Insurance Code, §102-101 (West Sept. 1999). Additionally, the charitable organization was to notify the Texas Insurance Department's annuities division of certain information, in writing, on the date on which it entered into its first qualified CGA agreement. See, Vernon's Tex Code Ann., Insurance Code, §1.141A, Sec. 4(a) (West 1995); Vernon's Tex Code Ann., Insurance Code, §102-102 (West Sept.1999). In fact, MAF was insolvent at the time it issued the first CGAs in issue (see, SOF, A.3-5), it had not been in continuous operation for three years before selling its first CGA in Texas (see, SOF, B.1); only CGA No. 20922 contained the language mandated by Texas law - none of the other thirty CGAs sold by Lankford contained the requisite
Document 464

10 11 12 13 14 15 16 17 18 19 20 21 22 23

Case 2:03-cv-02390-JAT

31 Filed 12/29/2005

Page 31 of 38

1 2 3 4 5 6 7 8 9
Guttilla & Murphy, PC
4150 West Northern Ave Phoenix, Arizona 85051 (623) 937-2795

language (see, SOF, F.15.a.xiv, exhibits 74-104 (CGA policies)); and MAF did not notify the Texas Department of Insurance of that information required of it (see, SOF, F.16.a.). Accordingly, sale of MAF CGAs by Lankford violated state law. 6. The Sale of MAF CGAs by Defendant Richard was in Violation of Maine Law. Defendant Richard testified that he held an insurance license from the state of Maine since 1989. (See, SOF, F.9.a.i.A.) In 1999, Defendant Richard sold nine MAF CGAs to the same 79 year old person in Maine over a six month period. (See,