PETERSON v. MCGLADREY & PULLEN (April 3, 2012)

Gregory Bell established several mutual funds in 2002 and raised $2.5 billion. Most of the money was invested in companies controlled by Thomas Petters. It turns out that Petters was running a Ponzi scheme rather than a legitimate organization. He was exposed in late 2008. The funds lost approximately 60% of their value and entered bankruptcy. Ronald Peterson was appointed trustee. Peterson brought suit against McGladrey & Pullen, the funds' auditors. He alleged that the auditors were negligent in failing to discover the irregularities. Judge Bucklo (N.D. Ill.) dismissed the complaint on in pari delicto grounds. Under that doctrine, one cannot claim to be the victim of a fraud in which one participated. Therefore, if Bell was in on the scam, neither he nor his funds have a claim against the auditors. Peterson appeals.

In their opinion, Seventh Circuit Chief Judge Easterbrook and Judges Bauer and Sykes vacated and remanded. The Court noted that Peterson's complaint alleges that Bell was part of the scheme beginning in early 2008 and seeks damages only for the auditors' activity prior to that time. The district court was wrong in presuming that Bell was involved earlier. The Court was not troubled by the fact that Peterson, as Trustee, had a separate suit against Bell alleging that he was involved in the scheme earlier then 2008. There is nothing wrong with inconsistent pleadings and, since that suit is still pending, the doctrine of judicial estoppel does not apply. Although the Court agreed with the Trustee that the district court erred, it rejected the Trustee's contention that the in pari delicto doctrine should not apply once a firm enters bankruptcy. Generally, bankruptcy law relies on state laws for defining property. If a state accepts the in pari delicto doctrine, it should be applied in the bankruptcy courts applying that state's laws.