Stolen Proceeds Distributed During Divorce

If a spouse receives assets during a divorce action and the assets turn out to be proceeds from fraud or theft, should the spouse be entitled to keep those assets? Or should the Courts step in and give back the money to innocent victims of fraud?

While these situations may seem farfetched, Courts have increasingly been faced with these questions. The infamous Bernie Madoff ponzi scheme is probably the most well known financial scandal of late. However, there are many other recent financial scandals, one of which recently intersected with New York Divorce Law. New Yorkers Paul Greenwood and Stephen Walsh allegedly ran a fraudulent commodities trading company, WG Trading Investors. Starting in 1996, Greenwood and Walsh used the funds as their own “piggy bank” and misappropriated over $550 million from their clients. The firm’s assets were frozen and in 2009, the SEC filed a civil complaint in federal court in Manhattan charging the men with fraud. They also faced criminal charges. While Mr. Greenwood pleaded guilty in 2010, Mr. Walsh’s criminal charges are pending. For more information on this scandal, please click here:

Stephen Walsh and his ex-wife, Janet Schaberg, were divorced in 2007, two years before the civil and criminal charges were brought. As a result of the divorce they divided their assets and Mr. Walsh’s ex-wife received millions of dollars, most of which were likely the fraudulent monies that her husband misappropriated. In August 2009, a federal judge froze most of Ms. Schaberg’s assets, including $7.6 million in cash, to potentially give back to the victims of the misappropriation. However, the New York Court of Appeals advised the federal court that under New York law, Ms. Schaberg was entitled to retain this money and the freeze was lifted.

The Court held that Ms. Schaberg could keep the proceeds from the divorce agreement, even if those proceeds were the result of her husband’s financial fraud. The Court ruled that because there was no indication that she was aware of or participated in any wrongdoing related to her ex-husband’s fraudulent scheme, she was entitled to keep the proceeds. Justice Victoria A. Graffeo stated, “Ex-spouses have a reasonable expectation that, once their marriage has been dissolved and their property divided, they will be free to move on with their lives.” The fact that the spouse was innocent of the wrongdoing was a major consideration by the Court, which stated, “Most definitely, the victims of fraud are entitled to pursue disgorgement where it is demonstrated that the transferee-spouse was aware of or participated in the fraud or otherwise failed to act in good faith.” In all, New York Courts seem very reluctant to adjust bargained for asset distributions. Therefore, marital property can include the proceeds of fraud and ex-spouses can keep stolen property if he or she had no knowledge of the fraud and gave fair consideration for the divorce settlement.