                            In the
 United States Court of Appeals
              For the Seventh Circuit
                         ____________

No. 03-1990
UNITED STATES OF AMERICA,
                                            Plaintiff-Appellant,
                               v.

LINDA K. FRYKHOLM,
                                                      Defendant.


Intervening Third-Party Claimant:
    COTSWOLD TRADING COMPANY, LTD.,
                                                         Appellee.

                         ____________
       Appeal from the United States District Court for the
         Northern District of Illinois, Western Division.
         No. 00 CR 50001—Philip G. Reinhard, Judge.
                         ____________
  ARGUED FEBRUARY 27, 2004—DECIDED MARCH 25, 2004
                   ____________


 Before EASTERBROOK, MANION, and EVANS, Circuit
Judges.
   EASTERBROOK, Circuit Judge. Linda Frykholm must have
the tongue of an angel, though she has the morals of a
fiend. She persuaded people to invest $15 million in a
get-rich-quick scheme, even though the promises she made
were transparently too good to be true (100% return in a
month) and she had no means to back her promises. Her
2                                                    No. 03-1990

only relevant credential was a 1994 conviction for theft and
forgery, which she did not tout; her “business address” was
a mail drop; routine inquiry would have disclosed that the
corporations through which she purported to do business
did not exist and that Illinois securities officials had
entered a stop order against her promotions. Her persua-
siveness was augmented, however, by the staple ingredient
of any Ponzi scheme: the first generation of investors
was handsomely rewarded with money being raised from
the next generation, and these ecstatic clients became her
avid promoters. Yet collapse was inevitable. The system
works only while each new generation of investors puts in
at least twice as much as the last, and exponential growth
cannot last: after a few doublings there aren’t enough
suckers left in the whole world. When Frykholm’s scam
imploded she had net receipts of about $10 million (having
taken in $15 million and paid out $5 million), of which
prosecutors have been able to locate some $4 million; the
rest either was devoted to living the high life or has been
hidden someplace from which Frykholm hopes to retrieve it
after her release. (We affirmed her sentence, 144 months’
imprisonment, in United States v. Frykholm, 267 F.3d 604
(7th Cir. 2001).) At least the asset recoveries are enough to
return about 30% of the victims’ losses.† Forfeiture of all
assets traceable to the scam’s proceeds is part of Frykholm’s
sentence, and the United States plans to use these assets to
make restitution to victims, as 21 U.S.C. §853(n)(1) permits.



†
  The figures in the text might lead one to think that the payout
would be closer to 40%, but that’s not right. Frykholm paid out the
$5 million against about $2.5 million in investment. That’s why
the first wave of investors was so enthusiastic. The unpaid
investors chipped in about $12.5 million, and $4 million is avail-
able to them. If Cotswold prevails in this litigation, then about
$1.8 million will be left to satisfy about $9 million in victims’
claims.
No. 03-1990                                                  3

  Title to all forfeitable assets vests in the United States as
soon as criminal proceeds are invested; a judgment of
forfeiture just confirms that this has occurred. 21 U.S.C.
§853(c). Third parties who acquire interests in the property
between the date of the act allowing forfeiture and the date
of the judgment may be taken unawares, and §853(c)
shelters their interests to the extent that “the transferee
establishes in a hearing pursuant to subsection (n) that he
is a bona fide purchaser for value of such property who
at the time of purchase was reasonably without cause to
believe that the property was subject to forfeiture under
this section.”
  Cotswold Trading Company, one of Frykholm’s victims,
made a claim to some of her assets under §853(c). Cotswold
entrusted a total of $1.1 million to Frykholm. The initial
investment of $100,000, made in March 1999, was to be
doubled and repaid within 35 days. When Frykholm did not
keep her promise, Cotswold decided to throw good money
after bad. It invested another $1 million in exchange for a
promise that Frykholm would deliver $2 million within 13
business days. That money came due in mid-July 1999.
Again Frykholm did not pay, though she used several
variations on “the check is in the mail”. Cotswold then
“reinvested” the promised but unpaid $2 million in ex-
change for Frykholm’s promise to pay it $4 million within
15 banking days. That obligation came due in late August
1999. All Frykholm delivered was more promises.
  Cotswold’s lawyer and its principal owner protested by
phone, fax, and letter; they threatened to file suit and
report Frykholm to the U.S. Attorney. Frykholm continued
making promises, but the wire transfers never materialized
and her checks bounced. In November 1999 Frykholm and
Cotswold executed a settlement and release. Frykholm gave
Cotswold a promissory note for $2.2 million due in 100 days
and secured by her interest in real estate on Lake Geneva,
Wisconsin. For convenience we call this parcel, at 1982
4                                                 No. 03-1990

North Lake Shore Drive in Delavan, Walworth County,
Wisconsin, “the Property.” Frykholm had purchased the
Property for $2,280,000 in January 1999. She paid with 17
checks written by other victims of the scam, so the Property
was unencumbered until Frykholm gave Cotswold a
mortgage. In January 2000 Frykholm was indicted, and the
United States filed a lis pendens against the Property.
Frykholm never paid the $2.2 million due on the note, and
Cotswold now wants to enforce its security interest.
   The Property is among the assets ordered forfeited to
the United States as representing proceeds of the crime.
Cotswold asserted that its interest is superior under §853(c)
and (n)(6)(B). The latter subsection says that a third party
prevails if it “is a bona fide purchaser for value of the right,
title, or interest in the property and was at the time of
purchase reasonably without cause to believe that the
property was subject to forfeiture under this section”.
Cotswold contends that it is a bona fide purchaser for value
under Wisconsin law, having given as “value” either the
$1.1 million it invested or the $4 million Frykholm owed.
The United States questions whether the holder of a
security interest given in exchange for an antecedent debt
can be a bona fide purchaser for value but has not pursued
the point—sensibly so. See Wis. Stat. §401.201(44)(b); see
also Swift v. Tyson, 41 U.S. (16 Pet.) 1 (1842), overruled on
other grounds by Erie R.R. v. Tompkins, 304 U.S. 64 (1938).
Its principal response is instead that Cotswold either had
“cause to believe that the property was subject to forfeiture”
or would have acquired such cause by conducting a reason-
able investigation. The district court, however, granted
summary judgment to Cotswold, ruling that although it
likely knew that Frykholm was perpetrating a fraud, it did
not know that the Property represented traceable proceeds
of that fraud, and thus did not know that the Property “was
subject to forfeiture”. 2002 U.S. Dist. LEXIS 22040 (N.D. Ill.
Nov. 12, 2002). As a result of the district court’s decision,
No. 03-1990                                                 5

Cotswold gets 200% of the amount it invested (making a
tidy profit from Frykholm’s scam), while the other victims’
recovery will fall to 15%, as the Property represents about
half of Frykholm’s traceable assets.
  On appeal the United States concentrates its energy
on contending that §853(b)(6)(B) asks, not simply what a
purchaser actually knows, but what it could have learned
after investigation. It is hard to see in this statute an
affirmative duty to inquire, but it may make sense to say
that what Cotswold actually knew would have alerted
any reasonable person to the possibility that real estate
purchased by someone perpetrating a financial fraud, and
unencumbered by any debt, represents funds skimmed from
the venture. A person who has this much knowledge, and
then averts his eyes lest he learn more, has actual knowl-
edge via the ostrich inference often used in criminal
prosecutions. See United States v. Ramsey, 785 F.2d 184
(7th Cir. 1986). A form of knowledge sufficient to support a
conviction beyond a reasonable doubt under a statute
requiring proof of scienter is more than sufficient to stave
off summary judgment in civil litigation. It is hard to go
beyond the ostrich inference in the direction of an inves-
tigation requirement; after all, the principal function of
the bona-fide-purchaser doctrine is to protect buyers that
did not investigate, and reading §853(n)(6)(B) to require
investigation as a condition of being an innocent purchaser
would all but vitiate the statute’s goal of protecting persons
who meet state-law definitions of bona fide purchasers for
value. See United States v. Lavin, 942 F.2d 177, 186 (3d Cir.
1991).
  The possibility that Cotswold knew enough to permit
an ostrich inference—and thus could be found to have ac-
tual knowledge that Frykholm bought the Property with the
proceeds of her fraudulent scheme—prevents summary
judgment in Cotswold’s favor. The state of Cotswold’s
knowledge is the subject of a material dispute. A remand for
6                                                No. 03-1990

trial is unnecessary, however, because the record shows
that Cotswold does not satisfy one state-law element of
bona-fide-purchaser status.
  In November 1999, when Cotswold exchanged its invest-
ment for the promissory note and mortgage, Frykholm was
insolvent. She owed more than $20 million to the investors
(all of whom had been promised a doubling, or in Cotswold’s
case quadrupling, of their funds) yet had only $4 million in
available assets. Her insolvency made the transaction a
fraudulent conveyance. Section 548(a)(1)(B) of the Bank-
ruptcy Code (11 U.S.C. §548(a)(1)(B)) provides a standard
definition of a fraudulent conveyance: a transfer in which
the debtor “(i) received less than a reasonably equivalent
value in exchange for such transfer or obligation; and (ii) (I)
was insolvent on the date that such transfer was made or
such obligation was incurred, or became insolvent as a
result of such transfer or obligation”. That definition (which
has a parallel in Wisconsin law, see Wis. Stat. §242.05) fits
this situation exactly. See also In re Loyal Cheese Co., 969
F.2d 515, 518-19 (7th Cir. 1992) (noting the similarity
between §548(a)(1) and Wisconsin law). Frykholm was
insolvent in November 1999 and did not receive reasonably
equivalent value for the exchange; indeed she received no
new value at all. Under the law of Wisconsin, a fraudulent
conveyance transfers no rights; it prevents the transferee
from achieving the status of a bona fide purchaser for value.
See Pippin v. Richards, 146 Wis. 69 (1911); Rindskopf v.
Myers, 87 Wis. 80 (1894).
  Neither side paid much attention to the effect of the
fraudulent conveyance, likely because both sides are rep-
resented by forfeiture specialists and have focused on the
language of §853 and opinions interpreting that statute.
Everything would have been clearer had the United States
initiated an involuntary bankruptcy proceeding against
Frykholm. That not only would have brought to the fore
§548 of the Bankruptcy Code but also would have provided
No. 03-1990                                                   7

a superior way to marshal Frykholm’s remaining assets and
distribute them to her creditors. Although §853(n)(1) allows
the Attorney General to use forfeited assets for restitution,
it does not create a comprehensive means of collecting and
distributing assets. Bankruptcy would have made it pellucid
that Cotswold cannot enjoy any priority over the other
victims and cannot reap a profit while Frykholm’s other
creditors go begging. Moreover, bankruptcy would have
enabled the trustee to recoup the sums distributed to the
first generation of investors, who received $5 million or so
against $2.5 million paid in. Those payments could have
been reclaimed under the trustee’s avoiding powers and
made available to all of the bilked investors. It is too late to
pursue the profits that Frykholm distributed to the first
wave of investors in order to set up the later waves, but it
is not too late to prevent the preferential distribution of any
further assets to favored investors. Cotswold must stand in
line with the rest.
                                                    REVERSED

A true Copy:
       Teste:

                         ________________________________
                         Clerk of the United States Court of
                           Appeals for the Seventh Circuit




                    USCA-02-C-0072—3-25-04
