Robert F. Anderson v. Morgan Keegan & Company, Inc.

Citation: Not availableDocket: 21-1536

Court: Court of Appeals for the Fourth Circuit; April 19, 2022; Federal Appellate Court

Original Court Document: View Document

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

Infinity Business Group engaged in questionable accounting practices that inflated its accounts receivable and revenues, a scheme devised by CEO Byron Sturgill, who falsely claimed to be a certified public accountant. The board of directors and external auditors endorsed this practice, leading to legal consequences for some individuals involved. The bankruptcy trustee, Robert F. Anderson, contended that Morgan Keegan, a financial services firm, played a crucial role in perpetuating these flawed practices. However, both the bankruptcy and district courts ruled that the trustee could not hold Morgan Keegan liable due to the legal principle that one wrongdoer cannot seek recovery from another for shared misconduct. Infinity had sought Morgan Keegan’s assistance for a private placement of stock and was responsible for providing accurate financial information, which Morgan Keegan could rely on without verification. The appeal, decided on April 19, 2022, affirmed the lower courts' decisions, emphasizing the trustee's inability to establish liability against Morgan Keegan despite allegations of their involvement.

Morgan Keegan's primary task involved creating a confidential information memorandum for potential investors, incorporating Infinity's financial data from 2003 to 2005, which was provided by CEO Sturgill. The 2005 financials showed a substantial increase in accounts receivable by over $9 million, raising concerns from Meyers of Morgan Keegan. Sturgill attributed this increase to a change in reporting practices and new business activities, claiming compliance with generally accepted accounting principles (GAAP), a position supported by Infinity's external auditors, despite later consensus that the accounting method was not GAAP-compliant. Trusting Sturgill's assertions, Morgan Keegan included the financial statements in the memorandum, which emphasized the need for thorough due diligence by prospective buyers.

Bison Capital, a potential investor, initiated due diligence but requested historical success rate data concerning accounts receivable. Morgan Keegan employee Calvin Clark assisted in preparing this data but used a methodology that excluded checks older than 60 days. Bison noted the limited sample size in their analysis, which raised concerns about its accuracy. Ultimately, Bison's due diligence uncovered misrepresentations about Sturgill's credentials, leading to the collapse of the deal. Eastside Partners also withdrew after similar findings about Sturgill. As a result, Morgan Keegan failed to attract further institutional investor interest in 2006. However, it helped Infinity adapt materials for other purposes, including a line of credit application. During this time, Infinity revised its 2003 and 2004 financial statements, extending the same questionable accounting practices, which received auditor approval. Morgan Keegan's role in these efforts was primarily limited to minor edits and adapting previous materials without significant new contributions.

Meyers terminated Morgan Keegan's relationship with Infinity on October 31, 2006, following failed deals with Bison and Eastside. During an exit interview, he provided recommendations aimed at improving Infinity's operations, including: sharing background reports among leadership, hiring a more credible accounting firm for audits, and adopting conservative accounting practices by writing off current receivables. At the time, Ernst & Young also questioned Infinity's accounting methods in communication with the company's CEO and securities counsel, though not with Meyers.

At a January 2007 board meeting, the board unanimously decided to maintain the existing revenue recognition method, reflecting a reluctance to alter their accounting practices. There is no evidence that Morgan Keegan or Meyers attended this meeting, and Morgan Keegan had minimal involvement with Infinity throughout 2007, limited to occasional communications. Meyers personally invested $50,000 in Infinity and was approached in December 2007 regarding new potential investors; he was surprised to learn that his recommendation to write off accounts receivable had not been implemented.

In April 2008, Infinity re-engaged Morgan Keegan to seek mezzanine debt, with the new agreement including provisions for financial advisory services and due diligence. By this time, Infinity was finally contemplating a more conservative accounting policy. Meyers identified two potential lenders, but one withdrew after learning about the receivables issue, while the other, the Morgan Keegan Strategic Fund, engaged Transaction Services for due diligence. Their report revealed that Infinity's accounting practices were not compliant with generally accepted accounting principles, marking the first documented acknowledgment of the issue. Despite Meyers' continued advocacy for a policy change, Infinity's management, including Sturgill, resisted alterations to avoid concerns from existing shareholders.

The Strategic Fund intended to extend mezzanine debt to Infinity and prepared a term sheet, but Infinity rejected the offer due to unfavorable terms regarding stock retention after debt repayment. Consequently, Morgan Keegan did not receive compensation. Apart from a brief 2008 sales conference presentation and a conversation with an investor, Morgan Keegan and Meyers ceased involvement with Infinity. Infinity struggled financially for two more years and, in 2010, filed for Chapter 7 bankruptcy after key management was removed. The bankruptcy court appointed a trustee, who sought to recover assets from Infinity’s management, its external auditor, Morgan Keegan, and Meyers. Most defendants defaulted or settled, leaving only Morgan Keegan and Meyers to contest the claims. The trustee argued that an accounting technique caused Infinity's collapse and attributed primary fault to the defendants under various legal theories. After an 18-day trial, the bankruptcy court ruled in favor of Morgan Keegan and Meyers, stating the trustee failed to establish the claims' essential elements and that the in pari delicto defense applied, indicating Infinity's management bore greater fault for the accounting issues. The district court upheld the bankruptcy court's decision, affirming both the claims' deficiencies and the application of in pari delicto. This doctrine prevents a plaintiff with equal or greater fault from obtaining relief.

The trustee on appeal does not dispute the bankruptcy court’s finding that Infinity's management is primarily at fault compared to Morgan Keegan or Meyers, despite any alleged involvement by Morgan Keegan in the accounting policy. The trustee raises four legal arguments against applying the doctrine of in pari delicto, but the court finds no merit in these claims and upholds the bankruptcy court's application of in pari delicto to dismiss the trustee's actions.

The trustee argues that he represents both Infinity and its creditors and claims immunity from in pari delicto when acting on behalf of creditors. However, established law indicates that a trustee acts as a representative of the estate, possessing only the causes of action available to the debtor, and is subject to the same defenses, including in pari delicto. This means that if in pari delicto would prevent the debtor from suing, it similarly prevents the trustee from doing so.

Additionally, while the Bankruptcy Code allows trustees certain powers beyond those of the debtor, including the ability to pursue actions a hypothetical judgment lien creditor could take, the trustee's reliance on this provision raises questions. Specifically, it must be determined whether a judgment lien creditor could pursue the debtor’s claims under applicable state law and whether such a creditor would also be subject to in pari delicto. The trustee assumes a judgment lien creditor could pursue all claims but offers little support for this assumption regarding the relevant laws of South Carolina or Nevada, where the claims have been asserted. Nevada law, for example, limits judgment creditors to pursuing only claims the debtor can assign.

In the context of a bankruptcy action, the defense of in pari delicto (meaning "in equal fault") is applicable, as established in Grayson Consulting. This principle asserts that a trustee, standing in the shoes of the debtor, can utilize the same defenses as the debtor, including in pari delicto. As the trustee's claims are based on 11 U.S.C. § 541 and § 544, the hypothetical judgment lien creditor would also share the same defenses as the debtor. The trustee's failure to demonstrate how Morgan Keegan and Meyers received a preference or transfer under 11 U.S.C. §§ 547, 548, or 550 limits consideration of those provisions. The in pari delicto defense does not conflict with § 544(a), as it pertains to the debtor's knowledge rather than that of the trustee or creditors.

The trustee's argument that agency law prevents collusion defenses against those who work with corporate insiders fails due to factual findings. The bankruptcy court determined that Morgan Keegan and Meyers were not involved in collusion and lacked knowledge of any wrongdoing regarding Infinity’s accounting practices. The court found no evidence showing that Meyers recognized any illegitimacy in the accounting methods until informed by a report in 2008. The court deemed the trustee's inference that Meyers should have known based on his accounting background as speculative. Furthermore, the trustee's assertion that Infinity’s management officers acted adversely to the company, which would prevent their actions from being imputed to Infinity, was also unconvincing. The bankruptcy court's detailed factual analysis was upheld without the need for reversal.

The parties acknowledge that an adverse interest exception to the in pari delicto doctrine exists, but they dispute the level of adversity required in the actions of corporate officers to invoke it. The trustee agrees with Nevada's standard, which demands that an agent's actions must be completely adverse to the corporation, equating such actions to "outright theft or looting." However, the trustee argues that South Carolina would adopt a less strict standard, allowing for actions that are merely "clearly adverse." Despite this, the court finds no significant difference between "totally adverse" and "clearly adverse," and maintains that even under South Carolina's purportedly more lenient standard, the case does not support the trustee's position. The bankruptcy court noted numerous benefits derived by Infinity from the accounting practices in question, indicating that the trustee's interpretation could undermine the in pari delicto rule by applying the adverse interest exception to any misfeasance that might lead to liability.

The trustee also claims that in pari delicto should not apply in fiduciary duty cases, referencing Delaware's stance that it does not apply in suits by corporations against their fiduciaries or in cases involving auditors aiding breaches of duty. However, the court refutes this argument, asserting that Nevada applies in pari delicto even in cases involving fiduciary breaches. The Nevada Supreme Court has emphasized the importance of corporate governance, which would be compromised by a broad interpretation of the exception. Nevada employs a multifactor test to assess when in pari delicto may not apply, particularly when public protection is at stake or to prevent unjust enrichment. South Carolina's case law on this matter is less developed, but it has ruled in a similar case that in pari delicto barred a breach of fiduciary duty claim.

In South Carolina, the doctrine of in pari delicto applies robustly, as demonstrated in the case of Myatt, which indicated minimal concern regarding its application when defendants do not attempt to attribute their wrongful actions to the corporation. In the current case, Morgan Keegan and Meyers are not attempting to avoid liability by claiming their misconduct should be linked to Infinity; rather, they contend that the wrongful actions of Infinity's officers and directors surpass their own, thereby barring recovery. The court agrees that South Carolina would not prohibit the application of in pari delicto in this context, noting that Infinity's demise was primarily due to its own officers and auditors, not Morgan Keegan or Meyers. The latter's alleged failure to prevent the inevitable decline does not warrant liability. Consequently, the judgment favoring Morgan Keegan and Meyers is affirmed.