Bayou Group Ponzi scheme case poses questions for Madoff investors

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Bayou Group Ponzi scheme case poses questions for Madoff investors

By David Flaum (Contact), Memphis Commercial Appeal
Sunday, January 25, 2009

Investors who got money back from indicted New York financial guru Bernard Madoff may be looking over their shoulders at a bankruptcy court case in another investment scheme that blew up in 2006 and affected a number of Memphis investors.

That case involved Bayou Group, a Connecticut hedge fund that turned out to be a pyramid scheme.


The trustee in Bayou's bankruptcy case demanded money back from investors who got out within two years before the petition was filed in U.S. Bankruptcy Court in New York.

Judge Adlai S. Hardin Jr. agreed in a decision handed down in October, which is likely to be appealed.

No information has surfaced to confirm that anyone in Memphis had investments with Madoff.

Memphis-based Morgan Keegan & Co. had clients with Madoff investments, but all of those were through funds that invested in other funds, said Kathy Ridley, a spokeswoman. She had no information on whether any of those investors was from Memphis.

"The similarity is that both are alleged to be a Ponzi scheme which, in its simplest form, is using new investors' money to pay those who invested previously," said Shea Wellford, a partner in Martin, Tate, Morrow and Marston, a Memphis law firm. "That money is not from investment returns."

Bankruptcy law says that if an investment promoter makes payments to investors in attempt to defraud or deceive people, the trustee may try to get those payments back for the "estate" of the bankrupt firm to be shared by all investors and creditors.

Nonetheless, if an investor can show he asked for his money back in "good faith," he may be able to keep it, Wellford said.

In the Bayou case, the judge agreed with the trustee that if investors knew, or should have known, that their money was coming from a Ponzi scheme or that a fraud was being perpetrated, they can't redeem their funds in good faith.

Good faith, Judge Hardin wrote, means "he (the investor) demanded to take his investment out of the particular Bayou fund not because he had some information there was some infirmity in the fund, but because some other reason personal to him and extraneous to the well-being of the fund and its remaining investors."

Wellford considers that unfair.

If investors or their advisers are doing their jobs right, they're continually checking to make sure investments meet their requirements.

"You're punishing people who are out there doing what they're supposed to be doing," Wellford said.

Take Memphis-based Consulting Services Group, which advised some of its clients to invest in Bayou Group early in the decade. After a lawsuit against Bayou Group prompted CSG to take a close look at the fund, the firm advised its clients to get out in mid-2004. Many did.

One of those clients, UT Medical Group, which invested $2 million with Bayou, settled with the trustee, getting to keep its original investment, but sending back the $485,000 in supposed profits it was paid.

UT Medical Group officials declined comment, citing pending litigation.

Others, including Christian Brothers High School, are fighting the trustee's move and the judge's decision, which has not yet been officially entered as a court order.

CBHS invested $1.6 million between 2002 and 2004, according to bankruptcy court documents.

CBHS will appeal the judge's decision once it is entered, said Thomas Sullivan, chairman of the board of trustees.

The Bayou decision is not the only one on such matters, said Memphis-based Farris Bobango attorney Michael Coury, who acts as a trustee and represents trustees in bankruptcies.

The principle in cases like Bayou or Madoff in which there is a "criminal element" charged is that there couldn't have been any fair value given in response to a redemption because the managers gave money back to investors they got by defrauding other investors, Coury said.

"Case law is across the board," Coury said. "Some courts allow the trustees to recover only the excessive earnings paid, but not the return of principal. Others require the return of both. Still others have found that if the recipient had no knowledge of the scheme, he received a good faith transfer and could keep it," Coury said.

The Bayou decision is not final, said Bob Orians, a partner at Martin Tate.

A court order confirming the decision hasn't been entered, he said. Once that happens, investors have appeal rights.

"This thing won't be decided for years," Orians said.