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Commodity Futures Trading Commission v. Stephen Walsh

June 23, 2011

COMMODITY FUTURES TRADING COMMISSION, RESPONDENT,
v.
STEPHEN WALSH, ET AL., DEFENDANTS, JANET WALSH, APPELLANT.
SECURITIES AND EXCHANGE COMMISSION, RESPONDENT,
v.
WG TRADING INVESTORS, L.P., ET AL., DEFENDANTS,
ROBIN GREENWOOD, RELIEF DEFENDANT,
JANET WALSH, APPELLANT.



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

This opinion is uncorrected and subject to revision before publication in the New York Reports.

Stephen Walsh is a defendant in related actions brought by plaintiffs Commodity Futures Trading Commission and Securities and Exchange Commission (the Agencies) alleging violations of the anti-fraud provisions of the Commodity Exchange Act and theSecurities Exchange Act. The Agencies claim that between 1996 and 2009, Walsh and his co-defendant, Paul Greenwood, misappropriated more than $550 million from funds they managed for various public and private institutional investors.*fn1

The Agencies also pursued disgorgement efforts against Janet Schaberg, the former spouse of Walsh, seeking to recover any proceeds she held of the fraud perpetuated by Walsh. Although there is no indication that she was aware of or participated in any wrongdoing related to her ex-husband's fraudulent scheme, the Agencies allege that a sizable amount of property derived from Walsh's illegal securities activities went into Schaberg's possession under the parties' separation agreement and divorce decree.

The United States Court of Appeals for the Second Circuit asks us two questions to assist it in discerning whether Schaberg has a legitimate claim to those funds, which would prevent the Agencies from obtaining disgorgement from her. These questions involve the interplay of the Domestic Relations Law and the Debtor and Creditor Law and implicate significant public policy considerations.

Background

Walsh and Schaberg were married in 1982 and have two children. Over the course of their 25-year marriage, Walsh was a substantial shareholder in or a management partner of a number of successful business enterprises, such as Champion Sportswear and Tanger Malls/Prime Outlets. As a couple, they acquired a number of homes, including condominiums in Florida and New York City, and a house in Port Washington, New York. Schaberg did not have outside employment during the marriage, but she volunteered at a number of charitable organizations.

In 2004, Schaberg and Walsh separated and divorce proceedings were initiated in early 2005. They entered into a "Stipulation of Settlement and Agreement" in November 2006 pursuant to Domestic Relations Law § 236 (B) (3). Under the terms of the agreement, Schaberg conveyed her ownership interest in the Port Washington marital residence (with an alleged value of about $7.5 million) to Walsh and she received sole ownership of the condominiums in New York City and Florida (with an alleged value of approximately $6.7 million). The agreement also provided that Schaberg would retain nearly $5 million held in several checking accounts and Walsh waived all claims to such monies. Walsh further agreed to pay Schaberg a distributive award of $12.5 million, payable in biannual installment payments through 2020.*fn2 As part of the settlement, Schaberg further waived any claim for maintenance based on the parties' lengthy marriage and, except as otherwise provided in the agreement, relinquished her right "to a distributive award or an award of equitable distribution with respect to any property acquired by [Walsh] either before or during the marriage." In April 2007, the settlement agreement was incorporated, but not merged, into the parties' final judgment of divorce. Schaberg moved to Florida in 2007 and remarried a year later.

Nearly two years after entry of the judgment of divorce, the Agencies filed separate complaints in the United States District Court for the Southern District of New York alleging large-scale fraud by Walsh, Greenwood and various investment entities they controlled. Both complaints sought monetary penalties from the named defendants and disgorgement of ill-gotten gains from the defendants and relief defendants alike. Schaberg was named as a relief defendant, along with other parties believed to be in possession of proceeds from the fraudulent securities scheme.

The District Court granted the Agencies' requests for preliminary injunctions freezing six of Schaberg's brokerage and bank accounts containing approximately $7.6 million. The court also prohibited Schaberg from transferring any real property, jewelry or artwork without court approval, thereby effectively freezing the bulk of her assets. Schaberg appealed, arguing that the District Court erred in issuing the injunctions because the property targeted by the injunctions was not subject to disgorgement.

The Second Circuit recognized that federal district courts have the power to order disgorgement from a relief defendant upon a finding that the party "(1) is in possession of ill-gotten funds and (2) lacks a legitimate claim to those funds" (618 F3d 218, 225 [2d Cir 2010]). In this case, the Second Circuit has determined that the question as to whether the injunctions were properly issued turns on whether the District Court correctly found, as a matter of law, that Schaberg lacked a legitimate claim to the funds.*fn3 Acknowledging Schaberg's assertion that she has a valid claim to the funds because "she acquired her assets pursuant to the separation agreement she executed with Walsh in their divorce proceedings, and that by executing this agreement she became a good faith purchaser for value of the assets" (id. at 226), the Court held that resolution of Schaberg's contention implicated open issues of New York law. The Second Circuit therefore certified the following two questions to us:

"(1) Does 'marital property' within the meaning of New York Domestic Relations Law § 236 include the proceeds of fraud?

"(2) Does a spouse pay 'fair consideration' according to the terms of New York Debtor and Creditor Law § 272 when she relinquishes in good faith a claim to the proceeds of fraud?" (id. at 231-232).

The Second Circuit also invited this Court to "reformulate these questions as it sees fit, or expand them to address any other issues of New York law ...


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