CFTC v. Walsh: Fraud and the Financial Benefits of Divorce

In Commodity Futures Trading Comm. v. Walsh, No. 91, (N.Y. June 23, 2011), the court held Janet Schaberg, the ex-spouse of Stephen Walsh, was entitled to keep assets awarded during her divorce, even if those assets turned out to be  proceeds from fraud.  Stephen Walsh and his partner, Paul Greenwood, are currently defendants in a pending case brought by the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”).  The CFTC and SEC allege Walsh and Greenwood defrauded public and private investors of more than $550 million between 1996 and 2009.  There is no evidence that Schaberg had knowledge of Walsh’s activities. 

After 25 years of marriage, Schaberg and Walsh filed for divorce in 2005.  In 2006, Schaberg and Walsh entered into a Stipulation and Settlement Agreement under New York Domestic Relations Law §236(B)(3).  Under the stipulation, Schaberg received ownership of two properties in New York and Florida valued at $6.7 million and relinquished her interest in the couple’s Port Washington, New York home, valued at $7.5 million.  Schaberg also received $5 million held in bank accounts and a distributive award of $12.5 million payable by Walsh in installments through 2020. 

The CFTC and SEC filed their complaints in 2009. In the complaints, the agencies sought disgorgement of proceeds from the fraud against Walsh, Greenwood, and Schaberg.  Schaberg argued her divorce settlement was not subject to disgorgement because she became a “good faith purchaser for the value of the assets” when she entered into her divorce stipulation. 

To determine whether Schaberg’s property was subject to the agencies’ injunctions, the court first considered whether marital property included proceeds of fraud under New York law.  New York state law defined marital property as “all property acquired by either spouse during the marriage but before entering into a separation agreement.” The court concluded that property attained with the proceeds of fraud did constitute marital property and because marital property encompassed all property acquired during the marriage, marital assets could be transferred to an innocent spouse even if illegally acquired. 

The CFTC and SEC argued that the court should recognize an exception based on the public policy of returning stolen property to its rightful owner.  The court rejected this contention noting that money, though acquired through fraud, cannot be earmarked or traced.  Additionally, the court noted public policies favoring finality of business transactions and divorces, which enable ex-spouses to move forward with their lives. 

The court next considered whether Schaberg acted in good faith and paid fair consideration for the property she acquired from the divorce.  The CFTC and SEC argued that Schaberg did not give fair consideration by relinquishing her right to other marital property because it was all created by fraud thus resulting in illusory consideration.  Schaberg argued that she provided fair consideration and became a good faith purchaser.  Debtor and creditor law in New York defined a good faith purchaser as someone who has given fair consideration without knowledge of the fraud.  (Debtor and Creditor Law §278 [1])  To determine whether Schaberg paid fair consideration, the court looked at whether Schaberg relinquished rights to any untainted marital property and non-tangible assets.  The court left the question of fair consideration to the federal courts but did note that Schaberg not only relinquished her interests in the estate owned by the couple but also her right to inherit from Walsh and any claims to maintenance. 

The court concluded Schaberg’s claims to her divorce proceedings prevailed over the victims’ claims for disgorgement because she acted in good faith and had no knowledge of the fraud.  The court also noted New York’s strong public policy for finality of divorce proceedings.

The primary materials for this case may be found on the DU Corporate Governance website.