Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 25 years experience prosecuting and defending claims for clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases on under standard fee and alternative fee arrangements. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring an expert on fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Sunday, December 8, 2013

The Discovery Battlefield in Ponzi Scheme Cases

Posted by Kathy Bazoian Phelps

   Two recent decisions in Ponzi schemes cases highlight the importance of the discovery process and the discovery tactics that can be employed to either elicit or withhold information.

   Testimony of SEC Employees Not Required in Bernard Madoff Scheme

   In a case arising out of the Bernard Madoff scheme, a group of defendants in the Citco and Fairfield Greenwich Ltd. cases sought to take the depositions of two SEC employees. Anwar v. Fairfield Greenwich Ltd., 2013 U.S. Dist. LEXIS 168989 (S.D.N.Y. Nov. 26, 2013). In that case, the Defendants contended that the testimony of those witnesses would show that "the Defendants could not reasonably have been expected to discover the Madoff fraud at an earlier time since the SEC itself was unable to do so despite its employees' frequent visits and interactions with BLMIS and its officers and employees, including Bernard L. Madoff." The plaintiffs in the case, along with the SEC, argued that the testimony sought lacked "meaningful relevance."

   Under Rule 45 of the Federal Rules of Civil Procedure, the court evaluated whether there would be an undue burden in compelling the testimony of the two witnesses and balanced the parties' interests by considering whether the information was necessary or available from another source. The defendants argued that the testimony was "critical" because it would "help establish that the Defendants could not 'have reasonably foreseen that the Fairfield defendants would fail to perform the expected due diligence and monitoring of the Fund's investments held by BLMIS . . .'" In comparison to the SEC’s investigation of Madoff, the defendants noted, "Madoff's ability to conceal the fraud from even the most determined investigators and examiners is highly relevant to whether the defendants could or should have uncovered Madoff's scheme."

   The court disagreed with the defendants, finding that the testimony would be "of marginal relevance," and stated:
The mere fact that a government agency charged with assessing BLMIS's regulatory compliance failed to discover Madoff's wrongdoing in a timely manner hardly suggests that the Defendants could not have done so had they taken additional steps in the course of auditing FGG. Indeed, in order to capitalize on the SEC's conceded failure to uncover the fraud at an earlier time, the Defendants would have to establish that they and the SEC were similarly situated, and that the SEC competently discharged its regulatory and investigative functions.
   Testimony of Receiver in Arthur Nadel Scheme Was Required

   In litigation pending in the Arthur Nadel Ponzi scheme case, the court-appointed receiver refused to answer questions at his deposition in connection with a fraudulent transfer lawsuit that he had commenced against Wells Fargo Bank. The receiver asserted the attorney-client privilege, contending that all of his knowledge about the case came from his communications with his lawyer, and that "Wells Fargo asked questions that seek legal theories, strategies, and conclusions conveyed to Receiver by his attorneys." Wiand v. Wells Fargo Bank, N.A., 2013 U.S. Dist. LEXIS 166375 (M.D. Fla. Nov. 22, 2013). The receiver claimed that the disputed questions, while appearing to request factual information, require interpretation of legal terms of art. Because his answers would necessarily reveal the legal conclusions of his attorneys, Receiver maintains that he properly refused to answer them.

   Wells Fargo argued that the "Receiver is using the attorney-client privilege to 'shield facts from discovery simply because those facts were conveyed to him by his attorneys.'" Wells Fargo also argued that the "Receiver's refusal to answer questions conflicts with the 'sword and shield' doctrine. That doctrine states that 'a party who raises a claim that will necessarily require proof by way of a privileged communication cannot insist that the communication is privileged.'"

   The court identified the following standard for what questions must be answered at a deposition:
During a deposition, a person may instruct a deponent not to answer a question only: (1) when necessary to preserve a privilege, (2) to enforce a limitation ordered by the court, or (3) to protect a witness from an examination being conducted in bad faith or in such a manner as to unreasonably annoy, embarrass, or oppress the deponent. Fed. R. Civ. P. 30(c)(2).   
   While the court concluded that some of the deposition questions encroach on privileged communications, it concluded that some were factual in nature and should be answered. The court directed the receiver to respond to the following 7 questions and limited the deposition to one hour:

(1) Does the receiver know whether its position is that under [the] origination [column], these are assets of the identified company or assets of the debtor?
(2) If Art Nadel has transferred money from Victory Fund to Scoop Capital, as the transferee, do you believe that Art Nadel controls Scoop Capital?
(3) Is it your understanding that the destination account is the account into which the wired amounts were sent? 
(4) Do you believe that those accounts listed under destination account [on Exhibit B] were the recipient of the wired funds? 
(5) How did Wachovia execute a transfer if it wasn't a transferor bank? 
(6) Factually what's the period of time in which the receiver believes it can recover for the fraudulent transfer claims? What period of time? 
(7) Does the receiver believe that all transfers dating back to 2002 are subject to recovery in this action? 
   Are Discovery Games Worth it?

   These two cases leave the question pending about whether it is worth it to object to propounded discovery in the absence of compelling circumstances.
  
   In the Madoff case, one has to wonder why the relevance objections over the SEC employee testimony made it all the way to court and then became the subject of a written opinion. Perhaps it is because trial lawyers love relevance objections as it provides another opportunity to state and remind the court of the party's theory of the case. Did the defendants accomplish that objective in this case, or did the defendants unnecessarily associate themselves with the admitted negligence of the SEC in failing to detect Madoff’s fraud?

   In the Nadel case, it's questionable whether the receiver came out ahead in his efforts to block discovery. Plaintiffs must be careful in trying to hide behind their attorneys, particularly where the plaintiff is a fiduciary like the receiver in that case. It is a risky strategy. The court might conclude that the receiver is trying to hide something or, worse yet, it could create an appealable issue if the receiver succeeds in the efforts to block discovery. Even though the receiver probably has no first-hand knowledge of anything, is it really worth the fight? 

   To avoid investing in a Ponzi scheme in the first place, read about my new book Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams at www.ponzi-proof.com

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