Peterson v. McGladrey & Pullen, Cayman et al

Filing 181

Enter MEMORANDUM Opinion and Order Signed by the Honorable Elaine E. Bucklo on 4/8/2014. Mailed notice (jdh)

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

Ronald
R.
Peterson,
not
individually but as Chapter 7
Trustee
for
the
bankrupt
estates of Lancelot Investors
Fund, L.P., Lancelot Investors
Fund
II,
L.P.,
Lancelot
Investors Fund Ltd., Colossus
Capital
Fund,
L.P.,
and
Colossus Capital Fund, Ltd.,
Plaintiff,
v.
General Electric Company, et
al.
Defendants.

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No. 10 C 274

MEMORANDUM OPINION AND ORDER
In this case, Ronald J. Peterson, in his capacity as the
Chapter 7 Trustee for the bankrupt estates of several investment
funds I collectively refer to as the “Lancelot Funds” or the
“Funds”1 has sued three related accounting firms (collectively,
“McGladrey”) and Simon Lesser, one of the firms’ partners. The
Trustee alleges that defendants’ negligent and reckless audits in
2007 and, alternatively, in 2008, failed to detect that the Funds
had

been

duped

into

investing,

from

2003

to

2007,

in

collateralized notes issued by an entity that turned out to be at
1

These are the Lancelot Investors Fund, L.P., the Lancelot
Investors Fund II, L.P., and the Lancelot Investors Fund Ltd. In
the Third Amended Complaint, the Trustee states that he is no
longer pursuing claims on behalf of Colossus Capital Fund, L.P., or
Colossus Capital Fund, Ltd.

the heart of a Ponzi scheme orchestrated by Thomas Petters.
Before

me

is

defendants’

motion

for

summary

asserts two bases for judgment in their favor.

judgment,

which

Defendants first

claim that the equitable affirmative defense of in pari delicto
bars

the

Trustee

against them.

from

obtaining

any

recovery

on

his

claims

Second, they argue that an exculpation clause in

their contract with the Funds also bars the relief the Trustee
seeks.

As explained below, I agree that the undisputed facts

establish the first of these affirmative defenses. Accordingly I
need not reach the second.
I.
I previously dismissed an earlier iteration of the Trustee’s
complaint, concluding that allegations that the Funds’ manager,
Gregory

Bell,

discovered

and

began

participating

in

Petters’

scheme during the time period for which the Trustee sought to
recover losses on behalf of the Funds, established that the Funds
were, indeed, in pari delicto with (i.e., at least as culpable
as) defendants for those losses.
my

conclusion

that

Bell’s

The Seventh Circuit agreed with

knowledge

was

attributable

to

the

Funds, and held that “if Bell was in on Petters’s scam, then the
Funds have no claim against McGladrey for failing to detect and
warn the Funds about something that Bell, and thus the Funds,
already understood.” Peterson v. McGladrey & Pullen, LLP, 676
F.3d 594 (7th Cir. 2012)(“McGladrey”).
2

But because the appellate

court disagreed that the Trustee’s pleadings alone established
Bell’s participation in the Ponzi scheme, it remanded the case
for further proceedings.
Since then, the Trustee has twice amended his complaint.
The substantive portion of the operative, Third Amended Complaint
begins by describing how Bell came to be acquainted with Petters,
then goes on to explain why Bell “trusted” Petters and why Bell
agreed to set up new hedge funds—including the Lancelot Funds—to
invest almost exclusively in an investment program that Petters
explained as follows:

a) Lancelot I would loan money to Thousand Lakes [a Special
Purpose Vehicle (“SPV”), owned and controlled by Petters
Company, Inc. (“PCI”)];
b) Thousand Lakes would issue SPV Notes to Lancelot I, which
would allocate/assign some of the Notes (or interests in the
Notes) to Lancelot II and/or Lancelot-Cayman;
c) Thousand Lakes was to use the loan proceeds to purchase
consumer electronics from either of two vendors, Enchanted
Family Buying Company or Nationwide Resources International,
Inc., to fulfill pre-existing purchase orders from Costco’s
subsidiary;
d) PCI was to have pre-sold those electronics to Costco’s
subsidiary (“National Distributors”), and PCI was to then
assign the purchase orders to Thousand Lakes; and
e) the SPV Notes were to be collateralized by Thousand Lakes’
(1) inventory of electronics stored in warehouses, and (2)
accounts receivable from National Distributors, which were
guaranteed by Costco for payment.
Third Amended Complaint, ¶ 15.
that

Petters

cultivated

The complaint goes on to explain

Bell’s
3

continued

confidence

in

the

legitimacy of this investment program by documenting each loan
the Funds made to Thousand Lakes with at least the following:

a) a National Distributors (Costco) purchase order to PCI, and
a Thousand Lakes invoice to National Distributors--providing
Bell
with
verification
of
the
accounts
receivable
collateral;
b) a
Thousand
Lakes
purchase
order
to
Nationwide
(or
Enchanted), and a wire transfer confirmation from Thousand
Lakes to Nationwide--providing Bell with verification of the
inventory collateral; and
c) a Thousand Lakes SPV Note to Lancelot I (which could be
assigned to Lancelot II and/or Lancelot-Cayman).
Id. at ¶ 17.
fabricated,

Of course, we now know that these documents were
that

there

was

no

collateral

supporting

the

SPV

Notes, and no transactions between any Petters entity and any
national

distributor.

But

according

to

the

Trustee,

Bell

“believed that Petters’ investment program as described in ¶ 15
was lawful, that the documents described in ¶¶ 16 and 17 were
genuine, and that the SPV Notes were collateralized.”

Id. at

¶ 18.
Indeed, the Third Amended Complaint paints a portrait of
Bell as an unwitting pawn in Petters’ fraud who made diligent—if
ultimately

futile—efforts

program was sound.

to

ensure

that

Petters’

investment

The Trustee explains, for example, that Bell

hired “reputable professionals” to ensure the legitimacy of the
investment

program,

and

that

none

of

them—two

nationally

recognized law firms, two audit firms (including defendants), and
4

others—ever

expressed

any

doubts

that

Petters’

investment

program, or the documents and collateral purporting to support
it, were not bona fide.2

The Trustee insists that Bell learned

no sooner than the world did that Petters’ investment program was
smoke and mirrors down to its very core.
In his Third Amended Complaint, the Trustee seeks to hold
defendants

liable

for

failing

to

uncover

Petters’

fraud.

Specifically, the Trustee claims that defendants failed: 1) to
“verify

the

existence

and

valuation

of

the

assets”

that

supposedly collateralized the notes the Funds issued; and 2) to
ascertain (and inform the Funds’ management) that the Funds’
internal controls were insufficient to detect and prevent fraud.
In their motion, defendants insist that even if the Trustee
could prove these allegations, Bell’s own, undisputed misconduct
as the Funds’ manager—including making false representations to
potential investors about the “flow of money” among the entities
involved in the investment program, and, later, engaging in a
series of fraudulent banking transactions in an effort to conceal

2

The Trustee sued at least one of these law firms in a case that
was likewise dismissed on the basis of in pari delicto.
The
Seventh Circuit affirmed the dismissal, though on different
grounds, in Peterson v. Winston and Strawn, LLP, 729 F.3d 750 (7th
Cir. 2013).
The appellate court noted that the Trustee had
instigated multiple suits against “solvent third parties,” citing,
in addition to this case, five bankruptcy avoidance actions. In a
consolidated appeal, the Seventh Circuit upheld the bankruptcy
court’s grant of summary judgment against the Trustee. Peterson v.
Somers Dublin Ltd., 729 F.3d 741 (7th Cir. 2013).
5

Thousand

Lakes’

delinquency

on

notes

held

Funds—contributed to the Funds’ alleged losses.

by

the

Accordingly,

they argue, in pari delicto bars the Trustee’s claim.
II.
As the Seventh Circuit previously held in this case, the
principle animating the in pari delicto defense is that “when the
plaintiff is as culpable as the defendant, if not more so, the
law will let the losses rest where they fell.”
F.3d

at

596.

The

Trustee

insists

that

McGladrey, 676

the

doctrine

is

inapplicable here because Bell’s misconduct amounts, at best, to
“a different fraud” from the one his complaint charges defendants
with

failing

to

detect.

But

the

Trustee’s

restrictive

construction of in pari delicto is not supported by the authority
on which he relies.
The

Trustee

begins

by

quoting

the

Seventh

Circuit’s

observation, in Williams Electronics Games, Inc. v. Garrity, 366
F.3d 569, 574 (7th Cir. 2004), that the doctrine “is intended for
situations in which the victim is a participant in the misconduct
giving rise to his claim.”
application here.
jury

instructions

But nothing in Williams precludes its

Indeed, the Williams court cited confusing
and

the

“adverse

interest”

principle

twice

rejected in this case as the bases for declining to apply it in
that case.

Id. at 575.

Nor do the Seventh Circuit’s remarks, in

this case, that “a participant in a fraud cannot claim to be a
6

victim of its own fraud,” and that the Trustee has no claim “if
Bell was in on Petters’ scam” 676 F.3d 596, imply that in pari
delicto applies, as the Trustee contends, only if Bell “knew
there

was

no

collateral

to

support

underlying sales transactions.”

the

SPV

Notes

Pl.’s Opp. at 6.

and

no

There is,

indeed, a factual dispute over whether Bell knew these facts.3
But defendants need not establish that Bell was as culpable as
Petters to prevail on their in pari delicto defense; they need
only show that Bell “bears equal fault for the alleged injury,”
as compared to the fault the Trustee attributes to defendants.
Knauer v. Jonathon Roberts Fin. Grp., Inc., 348 F.3d 230, 233
(7th Cir. 2003).
As

evidence

of

Bell’s

role

in

the

Funds’

collapse,

defendants highlight Bell’s misrepresentations about the “flow of
money” from the retailers that supposedly purchased inventory to
Thousand

Lakes,

then

from

Thousand

Lakes

to

the

Funds.

Defendants focus specifically on Bell’s representations about the
“lockbox”

account—a

Thousand

Lakes

3

bank

account

that

was

Defendants cite the testimony of Larry Reynolds, “a Petters coconspirator who purported to be one of the vendors from whom
Thousand Lakes was purchasing inventory.” Reynolds testified that,
in his view, Bell “came to believe, at some point, that there was
no economic substance to the transactions he was doing with
Petters,” that Bell knew it was all a scam” by 2007, and that
Petters told Reynolds Bell was a “partner of [theirs]” who “knew
all about it.”
Def.’s L.R. 56.1 Stmt., Exh. 16, Deposition of
Larry Reynolds, 65:8-66:1. Although the Trustee disputes that Bell
was a “a participant in Petters’ fraud,” he raises no objection to
this evidence.
7

controlled

by

the

Funds—that

ensured

that

the

money

flowing

through Thousand Lakes could not be diverted by Thousand Lakes
(or anyone else) while en route from the retailers to the Funds.
Indeed, it is beyond meaningful dispute that Bell materially
misrepresented the flow of money by telling potential investors,
systematically
retailers
account

would

when

“direct”

and

he

throughout

deposit
knew

retailer

the

payments

from

payments,

the
and

life

of

directly

beginning
that

the
into

that

every

Funds,
the

lockbox

there

payment

that

were
into

no
the

lockbox came from PCI, another Petters entity.
The Trustee argues that because the lockbox was designed to
eliminate the specific risk that money paid into the Thousand
Lakes account could be siphoned off before reaching the Funds,
and was not intended to protect against the distinct risk—which
Bell claims neither he nor anyone he consulted perceived—that the
money paid in had originated elsewhere than with the retailers,
Bell’s

misrepresentations

losses

the

Funds

to

suffered

investors
when

are

Petters’

divorced
scheme

from

fell

any

apart.

Setting aside the lack of support in the case law for this kind
of hair splitting, whatever the lockbox’s intended purpose, its
design as Bell represented it would have ensured transparency
with respect to the money’s origins.

More to the point, its

failure to operate as designed had the effect of concealing those
origins,

allowing

Petters’

scheme
8

to

flourish

undetected.

Indeed, Bell admits that had the lockbox functioned as it he
explained to investors, it would have allowed the Funds to see
“over and over and over again that money was coming from” the
retailer, and would have provided “persuasive evidence” that the
retailer “was an actual party to the transaction” with Thousand
Lakes.

Def.’s L.R. 56.1 Stmt., Exh. 1, Deposition of Gregory

Bell, 104:7-15.
with

the

That Bell himself claims to have been satisfied

evidence

Petters

fed

him—copies

of

putative

wire

payments from the retailers to PCI, see id. at 82:23-83:1—does
not make his misrepresentation to investors that money flowed
directly from retailers to a Funds-controlled account any less
culpable.
Moreover, in the same “Confidential Information Memoranda”
to

potential

investors

that

contained

misleading

diagrams,

flowcharts, and illustrations showing money flowing directly from
retailers to the Thousand Lakes lockbox, Bell represented that
the Funds would monitor Thousand Lakes “to confirm that [it]
satisfies its obligations under the Purchase Order, including,
without limitation, the delivery of the Underlying Goods to the
Retailer, and the payment by the Retailer to [Thousand Lakes] of
the purchase price of the Underlying Goods.”

Def.’s L.R. 56.1

Stmt., Exh. 3 [DN 154-3 at 13] (emphasis added).

This was also

untrue, of course, since had the Funds ever sought to monitor
“delivery of the Underlying Goods,” they would have discovered
9

that

no

such

goods

existed.

In

this

way,

too,

Bell’s

misrepresentations allowed the scheme to continue unabated.
Finally, there is no dispute that as the Petters entities
began

to

run

delinquent

out

on

of

some

new

of

money,

the

and

notes

Thousand

owned

by

Lakes

the

became

Funds,

Bell

affirmatively went “in” with Petters on a fraudulent, “secondtier Ponzi scheme,” Peterson v. Somers Dublin Ltd., 729 F.3d 741,
744 (7th Cir. 2013), wiring money from the Funds to Thousand
Lakes, which Thousand Lakes turned around and wired back to the
Funds

in

putative

satisfaction

of

the

overdue

notes.

Bell

engaged in scores of such “round-trip” transactions on the Funds’
behalf from February of 2008 until Petters’ scheme was exposed in
September of 2008.

Meanwhile, the Funds raised more than $200

million dollars from investors during this time, and also renewed
a

$50

million

intentional

line

of

misconduct

on

credit.
behalf

In
of

this
the

way,

Funds

too,

Bell’s

increased

the

Funds’ exposure to the losses that resulted when the Ponzi scheme
ultimately fell apart.
Undisputed evidence of these aspects of Bell’s involvement
in the Petters scheme is the crux of defendants’ in pari delicto
motion,

and

it

amply

establishes

that

Bell’s

misconduct

contributed to the Funds’ losses at least as significantly as the
negligence
defendants.

and

recklessness

with

which

the

Trustee

charges

Accordingly, I conclude that the doctrine of in pari
10

delicto bars the Trustee from recovering from defendants for the
losses he asserts on the Funds’ behalf.
III.
For the foregoing reasons, defendants’ motion for summary
judgment is granted.
ENTER ORDER:

_____________________________
Elaine E. Bucklo
United States District Judge
Dated: April 8, 2014

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