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In litigation connected to the Stanford International Bank, the Texas Supreme Court is considering a question of first impression that could determine if Stanford Bank's receiver can claw back $79 million from the largest investor of the collapsed Ponzi scheme.

The U.S. Court of Appeals for the Fifth Circuit vacated its January ruling in the case, Janvey v. GMAG, which found that receiver Ralph Janvey could claw back the money from investor Gary Magness. It found Magness couldn't claim a good-faith defense under the Texas Uniform Fraudulent Transfer Act since he was on notice of the fraudulent nature of funds that Stanford Bank transferred to him in 2008.

The state's high court on May 31 accepted the certified question, which the Fifth Circuit called “a significant issue of first impression” to interpret the uniform fraudulent transfer act's good faith defense. The Fifth Circuit will rehear the appeal after receiving the Texas Supreme Court's answer.

The Fifth Circuit's May 24 certified question provides the background of the case. The U.S. Securities and Exchange Commission in 2009 discovered the Stanford Bank Ponzi scheme in which Stanford Bank issued fraudulent certificates of deposit that promised high returns compared to other banks, but in fact, paid its investors' interest with new investors' funds. Over 18,000 investors lost $7 billion in the Ponzi scheme and the district court appointed Janvey as the receiver to recover and distribute Stanford Bank's assets to its victims.

Magness and entities where he keeps his wealth were among Stanford Bank's largest investors, with $79 million in certificates of deposit. Shortly after news broke in 2008 that the SEC was investigating Stanford Bank, Magness's financial adviser approached Stanford for a redemption. Stanford Bank suggested that Magness take loans on his accumulated interest instead, and Magness received multiple transfers totaling $88.2 million.

Janvey sued Magness to recover the funds, alleging they were fraudulent transfers and amounted to unjust enrichment. He won partial summary judgment to recover $8.5 million that exceeded Magness' initial investment.

The receiver sought a ruling that the remaining $79 million was fraudulent transfers, but Magness countered that he was entitled to the Texas Uniform Fraudulent Transfer Act's good-faith defense.

A jury found that Magness had inquiry notice of the fraudulent nature of the transfers. The district court found Magness should have conducted a diligent investigation, but did not. Even if he had investigated, it would have been futile because he couldn't have learned of the Ponzi scheme, the court ruled, finding he was entitled to the good-faith defense.

Janvey appealed to the Fifth Circuit, which disagreed with the lower court. It ruled for Janvey in January that the jury's finding that Magness had inquiry notice of the fraudulent nature of the transfers did defeat his good-faith defense. Next, Magness asked the panel to rehear the case, arguing that the Fifth Circuit should certify a question about the good-faith defense to the Texas Supreme Court.

The Fifth Circuit explained, “This brings us to the crux of this case: does TUFTA good faith require a transferee on inquiry notice to conduct an investigation, and if so, can that transferee retain the good-faith defense if he does not conduct an investigation but later convinces the factfinder that such an investigation would not have turned up the fraudulent purpose?”

Ballard Spahr partner Drew Petrie of Denver, who represents Magness, said it's an important and open question in Texas Law that the state's high court should decide.

“Our position is the law of inquiry notice or constructive notice is the objective standard that always requires a determination of whether it was knowable that there was something wrong,” he said. “In my perfect world, that's what would come back.”

But Baker Botts partner Kevin Sadler of Palo Alto, California, who represents Janvey, wrote in an email that Janvey is confident the Fifth Circuit decided the case correctly.

Sadler wrote, “The receiver looks forward to a decision from the Texas Supreme Court that will finally put to an end Magness' efforts to retain tens of millions of dollars in funds which rightfully belong to the victims of Stanford's fraud.”

Read the certified question.