On November 1, 2011, the Ohio Supreme Court is scheduled to hear oral argument in an unusual case where the Director of the Ohio Department of Commerce has sued to recover the proceeds of insurance policies from the family of Roy Dillabaugh, who operated a Ponzi scheme. The Second District Court of Appeals for Montgomery County previously held (in an Opinion available here) that the Director cannot seek to recover the proceeds, but a court-appointed Receiver has the authority to file such a suit (although the Court did not address any potential limits to the Receiver's authority on the grounds that the issue was not ripe for decision).
From 1994 to 2007, Mr. Dillabaugh operated the Dillabaugh Group – an unincorporated business entity which was not licensed to sell securities in Ohio. However, the company and Mr. Dillabaugh sold approximately $12 million in securities to 146 investors primarily located in Ohio and Indiana. Although he told investors the funds were invested in legitimate business activities and were guaranteed, Mr. Dillabaugh was operating a Ponzi scheme and using the funds to make purported "interest" payments to early investors and pay his own expenditures.
The personal expenditures included premium payments on dozens of life insurance policies for which Mr. Dillabaugh was the insured and his wife, son and secretary were the beneficiaries. In a letter opened after his death (which occurred in November 2007), Mr. Dillabaugh instructed his wife, son and secretary to cash in the various policies and repay investors. Although the beneficiaries have received the proceeds, the investors have not been repaid.
In June 2008, the Director of the Ohio Department of Commerce filed suit against the Dillabaugh Group and the estate of Mr. Dillabaugh, claiming violations of the Ohio Securities Act and seeking to recover the proceeds from the Ponzi scheme. The Director also named the wife, son and secretary as necessary parties and obtained a TRO to prevent the dispersal of any of the proceeds of the insurance policies. The Director did not claim that the wife, son and secretary violated the law. The trial court ultimately concluded that the Director and an appointed Receiver were creditors of the Dillabaugh Group and the estate, and were entitled to seek recovery of the insurance premiums paid for the policies, but not the entire amount paid out under the policy.
The Director appealed and Mr. Dillabaugh's wife and secretary cross-appealed. Mrs. Dillabaugh and Ms. Long (the secretary) argued that the Director may seek remedies against violators of the Ohio Securities Act only, and because they did not violate the Act, the Director could not recover funds from them. The Court of Appeals agreed, but noted that the Director could seek the appointment of a receiver, who would then have the authority to sue to recover the proceeds from the violation of the Ohio Securities Act.
With respect to the proceeds from the insurance policy, the Court of Appeals held that "[b]ecause we have concluded that the Director lacked the authority to sue third-parties, such as Mrs. Dillabaugh and Ms. Long, … the Director necessarily lacked the authority to seek a temporary restraining order and a preliminary injunction against them to prevent them from disposing of the proceeds of the insurance policy." The Court of Appeals held that the appointed Receiver had the authority to "marshal and preserve assets," it had not yet done so. Therefore, the issue of whether the Receiver could recover the full amount was not ripe for determination, and "[i]f the receiver wishes to pursue all of the proceeds of the life insurance policies …, he may attempt to do so in his own action, and the trial court may address [arguments regarding the issue], if raised, at that time."
The Brief filed by the Director of the Ohio Department of Commerce (available here) flags an important issue. In her Securities Law Prof Blog, Professor Barbara Black of the University of Cincinnati College of Law highlighted the argument by the Director that the decision by the Court of Appeals "if allowed to stand, creates a significant obstacle in the Division's power to act quickly to protect investors."