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

Thursday, February 28, 2013

February 2013 Ponzi Scheme Roundup

Posted by Kathy Bazoian Phelps

   The year continues its strong start for Ponzi scheme news. Here is the summary of the stories that were reported this month. Please feel free to post comments about these or other Ponzi schemes that I may have missed. And please remember that I am just relaying what’s in the news, not writing or verifying it.

   Matthew James Addy, 34, of Pennsylvania, pleaded guilty to charges in connection with a $3 million Ponzi scheme that involved the fake purchase and resale of wholesale jewelry and loose precious stones. Addy owned Edward J. & Company, which operated a retail jewelry store called La Porte Jewelers. Addy lured in 40 investors, many of them from religious groups with which he was affiliated, but never conducted the promised wholesale jewelry transactions.

   James W. "Bill" Bailey, Jr., 65, was sentenced to 32 years in prison in connection with his Ponzi scheme run through Southern Financial Services, which defrauded investors of more than $13 million. He dealt in asset management, individual retirement accounts, and wills and trusts, and he previously pleaded guilty to charges relating to his scheme.

   Darren Berg has asked the court to vacate his prison sentence in connection with the $140 million Ponzi scheme run through the Meridian Funds. Berg alleged that the trustee who administered Berg’s personal bankruptcy case "engaged in a conspiracy to elicit incriminating statements" from Berg when Berg’ attorneys were not present. Berg also argued that his attorneys provided an inadequate defense. Berg had previously pleaded guilty, was sentenced to 18 years in prison, and apologized to his victims at his sentencing, stating that "I did it consciously."

   Brian Anthony Bjork, 43, of Missouri, was charged in connection with a $1 million Ponzi scheme that defrauded approximately a dozen investors. Bjork had been employed as a registered investment advisor in J. David Financial Group and Select Asset Management, companies owned by deceased investment advisor Joel David Salinas. It is alleged that Bjork’s investment scheme was to solicit funds under the false pretense that he would either invest those funds in Salinas’ pawn shops or use those funds to purchase corporate bonds being offered by Salinas. Bjork had established a bank account over which he had sole signing authority in the name of Brian A. Bjork dba J David Financial Group.

   Julius Blackwelder, 59, of North Dakota, pleaded guilty to charges in connection with a $400,000 Ponzi scheme. Blackwelder is a former Mormon bishop whose victims included members of his congregation. He advised investors that he would invest the funds in safe, long-term commodities futures contracts. Instead, he used money to pay earlier investors, to build a waterfront home, and to repay personal bank loans.

   Karen P. Bowie, 61, of Texas, was sentenced to 80 years in prison for operating a Ponzi scheme through Titan Wealth Management LLC in which she sold fictitious high yield "European Mid-Term Notes" that she represented were issued by European banks. The scheme involved at least $4.7 million taken from investors, some of which was used by Bowie to purchase a coastal home in Maine. Thomas Lester Irby II was the owner of Titan Wealth, and he promised investors short-term returns of between 10% and 50%. Irby had told investors that their notes were protected by a $10 million note he owned that could be liquidated to pay them back. Irby was previously sentenced to 24 years in prison.

   Gerard Frank Cellette, 48, already serving an 8 year sentence in Minnesota for a $200 million Ponzi scheme, was charged in Orange County for losses of more than $21 million that took place in California. Cellette, through his company Minnesota Print Services, Inc., promised investors returns of 10% to 15% based upon false claims that he had large printing contracts with major corporations. Cellette never actually set foot in California. The scam also affected investors in Minnesota, Hawaii, Georgia, Arizona, Colorado, and Illinois. He is accused of using the ill-gotten gains to buy cars, private jets and multiple homes with features such as a go-kart track, bowling alley, and a 1950s malt shop.

   Fred David Clark, Jr., 54, David Schwartz, Cristal Coleman, 39, Barry Graham, and Ricky Lynn, all former real estate executives with Cay Clubs Resorts and Marinas, were sued by the SEC for allegedly running a $300 million Ponzi scheme in which almost 1,400 investors were defrauded. The SEC alleged that investors were promised guaranteed returns of 15% and future income through the Cay Clubs rental program. Clark has also been identified as having interests in CMZ Group, Ltd., a Cayman Islands entity that has ventures including CashWiz pawn shops, and Argentum Refineries, a precious metals processor and bullion storage operation in Cayman Enterprise City. CMZ Group also has a company called "Best4Less", a wholesale distribution company based in Turks and Caicos Islands that manufactures Pirates Choice rum.

   Kenneth Cobb, 46, who formerly served 78 months in prison for a worldwide $64 million Ponzi scheme, was just sentenced to be jailed on weekends for 8 months and to pay $32,000 in restitution for his theft of 8 saguaro cacti from federal land.

   David Connolly, 51, of New Jersey, pleaded guilty to charges in connection with a real estate investment Ponzi scheme that defrauded 200 victims of more than $50 million. Connolly told investors that he would use their money to buy specific properties that would generate monthly rental income to be distributed to them. He also told them that their money would be held in escrow until the closing of their real estate transaction. The scheme collapsed when Connolly began defaulting on mortgage payments.

   Nicholas T. Cox, 35, was sentenced to 3 years and ordered to pay $1.98 million in restitution after pleading guilty to charges in connection with a $3.2 million Ponzi scheme that he ran through Integra Capital Management LLC. The scheme was to defraud commodities trading investors. Last year the CFTC had ordered Cox, along with Rodney W. Whitney, to pay millions in restitution and penalties and to refrain from engaging in any commodity-related activity. It was alleged that, instead of investing money from clients, Cox and Whitney used the money to pay other investors and for personal expenses, including dining, entertainment, travel and real-estate purchases.

   Christopher Brown Cornett and Heidi Beryl Beyer received sentences of 40 years and 6 years, respectively, in connection with a Ponzi scheme that involved more than 150 people and resulted in more than $10 million in losses. The scheme involved trading in foreign currency exchange markets. The investors’ money was lost in bad trades and gambling, to make payments to investors, and to purchase a new Chevrolet Corvette.

   Jonathan Davey, 47, stood trial and was convicted for his role in a $40 million Ponzi scheme that he ran through a hedge fund called Black Diamond Capital Solutions that defrauded about 400 victims in North Carolina, Virginia and Ohio. Davey served as "Administrator" for numerous hedge funds, and he solicited over $11 million from victims for his own hedge fund called "Divine Circulation Services." Davey used a shell company in Belize to funnel money to buy 47 acres of land in Ohio and to build himself a mansion. The Black Diamond scheme was masterminded by Keith Simmons and was sold as a Forex trading operation that promised risk-free annual returns exceeding 20%. Simmons appealed to investors' faith, quoting Bible verses and stressing his devout Christianity to portray himself as trustworthy. The following individuals have also been convicted in the Black Diamond scheme:
  • Keith Franklin Simmons, 47, of North Carolina, was sentenced to 50 years in prison on May 23, 2012.
  • Bryan Keith Coats, 52, of North Carolina, pleaded guilty and was sentenced to 15 years in prison on November 16, 2012.
  • Deanna Ray Salazar, 55, of California pleaded guilty and was sentenced to 54 months in prison on May 23, 2012.
  • Jeffrey M. Muyres, 37, of North Carolina pleaded guilty and was sentenced to 23 months in prison on January 18, 2012.
  • Roy E. Scarboro, 48, of North Carolina, pleaded guilty and was sentenced to 26 months in prison on May 4, 2011.
  • James D. Jordan, 49, of Texas, pleaded guilty and was sentenced to 18 months in prison on June 29, 2011.
  • Stephen D. Lacy, 53, of South Carolina, pleaded and was sentenced to six months in prison on May 4, 2011.
  • Chad A. Sloat, 34, of Missouri, pleaded guilty and is currently awaiting sentenced.
  • Jeffrey M. Toft, 50, of Florida, pleaded and is currently awaiting sentencing.
  • Michael J. Murphy, 52, of Minnesota, pleaded and is currently awaiting sentencing.
   Garett "Denny" Denniston, 62, pleaded guilty to one charge in connection with his operation of a $2.5 million Ponzi scheme that defrauded more than 50 victims. Denniston ran his scheme through ConsensusOne that supposedly specialized in mergers and acquisition. He told investors that their money was invested in ConsensuOne-owned companies and that their investments were risk-free. Instead, he spent their money for gifts to family members and spent a large portion on airfare, hotels, restaurants, country club memberships, golf and ski vacations, mortgage and rent payments, cable and telephone bills, furniture, home renovation costs and other personal expenses.

   Jim Ellis entered a guilty plea in connection with his Ponzi scheme in which he defrauded Wilton Manors residents out of millions of dollars. Ellis admitted to conspiring with George Elia to defraud investors. Elia is scheduled to go to trial in March. In Ellis’ case, the government filed a motion to restrict the defense’s right to peremptorily exclude gay jurors, which the government anticipated because so many of the victims were members of that community. The government argued that "sexual orientation should be treated like race, gender and ethnicity for purposes of voir dire" in the process of picking jurors.

   Alice H. Everett, a former adviser with ING Financial Services and Allstate Financial Services, was banned from holding a license in the state of Florida after she was charged with selling shares of a Ponzi scheme known as Paramount Group, to 8 clients and shares of Minnesota Investment Group, a company of which she was VP, to 3 clients. The Paramount Group Ponzi scheme took place in St. Thomas, Virgin Islands and was revealed in 2010. Everett was previously barred by FINRA from working in the securities industry.

   Rodney Wade Grubbs, 43, had pleaded guilty last year to charges relating to a Ponzi scheme and was just sentenced to spend 2 more years in prison. Grubbs is still serving 30 years of probation from his guilty plea in the scheme where he had told investors he would use their money to purchase hotel rooms and tickets to concerts and sporting events, including the Super Bowl, the Ryder Cup, the Masters Tournament and the Kentucky Derby. He had defrauded 3 investors out of more than $500,000.

   Charles Huggins, 66, and Anne Thomas, 68, were charged in connection with a $2.5 million Ponzi scheme run through JYork Industries Inc. and Urogo Inc., which promised high returns from gold and diamond mines in Sierre Leone and Liberia. They said that they would use the investors’ funds to mine gold and diamonds and then sell them at a profit in the U.S. The scheme was based in New York City, but also involved Christopher Butchko, 43, of California.

   Samuel B. Jacobs, a religious broadcaster, was sentenced to 12 years in prison following is conviction relating to a Ponzi scheme that defrauded investors out of $787,000. Jacobs and his former business partner Christopher Rice were found guilty of running a Ponzi scheme that defrauded 80 to 100 investors.

   Howard G. Judah Jr., 82, and Gregory F. Jablonski, 62, were each sentenced to 10 years in prison for their role in a $30 million Ponzi scheme run through National Life Settlements LLC. They solicited money from both active and retired state employees and teachers and arranged to have their money rolled out of retirement funds and into National Life Settlements investments. However, Judah and Jablonski never acquired the necessary life insurance policies. Judah had been convicted three previous times and Jablonski had been the principal of a bankruptcy Internet network firm.

   Helmut Kiener, 53, was charged in Philadelphia in connection with a $311 million Ponzi scheme that he ran through hedge funds including K1 Global Limited, Oceanus, Mezzanine and K1 Invest. Kiener is already serving a 10 year sentence in Germany, as was reported in the January 2013 Ponzi Scheme Roundup. Kiener faces a maximum sentence of 200 years. An associate, John C. Tausche, 61, was also charged.

   James Stanley Koenig, 60, saw his trial begin in connection with a $250 million Ponzi scheme in which many elderly investors were defrauded. His former business partner, Gary Thomas Armitage, 62, pleaded no contest to charges in exchange for a 10 year sentence. Another former co-defendant, Jeffrey A. Guidi, entered into a plea agreement and agreed to cooperate with prosecutors. It is alleged that Koenig and Armitage hid crucial information from investors, including that Koenig was convicted of felony mail fraud in the 1980s. Koenig’s trial is expected to last a few months.

   Jason Konior, 39, was arrested on charges in connection with a $2 million Ponzi scheme involving 3 hedge fund investors. Konior promised investors that he would match their investments in his fund, Absolute Fund LP, up to 9 times. The complaint alleged that Konior advertised that his fund provided trading leverage to new and emerging hedge funds and that he would put the money into brokerage accounts that investors could use to trade securities. Instead, Konior allegedly took the money to pay his own expenses and cover redemption requests from prior investors.

   George G. Levin and Frank J. Preve partially prevailed on a motion to dismiss claims brought against them by the SEC. The court dismissed most of the claims but allowed a portion of one claim to stand. Levin and Preve were accused by the SEC of assisting Scott Rothstein in his $1.2 billion Ponzi scheme by defrauding investors to raise funds to purchase purported legal settlements from Rothstein. The SEC alleged that Levin and Preve offered promissory notes in Levin’s company, Banyon 1030-32, LLC, to raise money for Rothstein’s scheme. It is alleged that they "profited from the amount which the settlement discounts they obtained from Rothstein exceeded the rate of return promised to investors."

   Gilbert Lopez, 70, the former chief accounting officer of Stanford Financial Group, and Mark Kuhtr, 40, the former controller, were each sentenced to 20 years following their convictions last November. It is reported that the evidence at trial demonstrated that the two defendants knew Stanford was misusing the bank's assets, helped him conceal this misuse, and helped him deceive customers into believing he had infused hundreds of millions of dollars into the bank during the 2008 financial crisis. Laura Pendergest-Holt, the former chief investment officer was previously sentenced to 3 years and James Davis, the former chief financial officer, was previously sentenced to 5 years.

   Syed Qaisar Madad, 66, pleaded guilty to charges in connection with his $49 million Ponzi scheme that he ran through Technology for Telecommunication and Multimedia Inc. Madad. Madad targeted the Pakistani-American community and pitched what he represented was a successful day trading investment model. Madad spent more than $15 million of investors’ money on personal expenses such as real estate, jewelry for his wife and daughters, cars, and cash disbursement to himself and family members. As part of his agreement, Madad has agreed to forfeit his mansion, a Mercedez-Benz, 68 pieces of jewelry, and silk and wool handmade oriental carpets, among other things.

   Timothy McGinn, 64, and David Smith, 67, of New York, were convicted in connection with a Ponzi-like scheme. The two investment brokers were found guilty of diverting more than $4 million of their clients’ funds to pay personal expenses and to pay their firm’s employees and preferred clients. Both defendants face the possibility of 30 year prison sentences.

   Istvan A. Merchentaler, aka Steven Merchentaler, 42, was arrested and charged with defrauding investors of more than $2 million in connection with his Ponzi scheme run through PhoneCard USA. Merchentaler represented that PhoneCard was a "premier distribution source" for prepaid phone cards and cell phones that had contracts with Walmart, 7-Eleven and BJ’s Wholesale Club.

   W. Mark Miller, 59, Brendan W. Coughlin, 46, and Henry D. Harrison, 47, all from Texas, pleaded guilty to charges in connection with the $400 million oil and gas investment Ponzi scheme run through Provident by Joseph Blimline, 35, and Paul R. Melbye, 47. Coughlin and Harrison founded and controlled Provident and provided false information about oil and gas projects.

   Shawn H. Moore was found guilty of charges in connection with his role in operating the VesCor Capital real estate development Ponzi scheme. The $180 million scheme offered investments in real estate projects but was run as Ponzi scheme from inception with money from new investors going to pay previous investors in order to make the business appear profitable. Moore managed investor relations for VesCor, but failed to disclose the poor financial condition of the company when selling investments. VesCor Capital owner Val Southwick pleaded guilty in 2008 and was sentenced to 1 to 15 years in prison on each of 9 counts, with the sentences to run consecutively.

   Nicholas Mussolini, the CEO of Preston Waters, was arrested in connection with allegations that he was running a Ponzi scheme in which he promised high returns in connection with film financing. Preston Waters took in funds for purposes of supposedly financing 10 to 15 projects a year in the $20 million to $60 million budget range. Mussolini is facing up to 30 years in prison as well as a $ 1 million fine.

   Gurudeo "Buddy" Persaud, 47, had his federal indictment unsealed. Persaud is accused of running a $1 million Ponzi scheme through his private equity fund, White Elephant Trading Co., in which he based his trading model on lunar cycles and the gravitational pull of the moon and Earth. Persaud guaranteed returns of 6% to 18%.

   James Pantazelos, 64, was sentenced to 9 years after pleading guilty to charges in connection with his Ponzi-like scheme run through Destiny Partners, Inc. Investors were invited to conferences where they were promised returns of up to 200% and were guaranteed the return of their principal investment. Investors were told that their funds were invested in "Private Investment Trading Platforms," which traded bank notes in foreign markets, and that a substantial portion of profits generated would be donated to charitable and humanitarian causes.

   Richard Reynolds, 51, was denied his request for a reduction of his bail from $10 million to $100,000. Reynolds, who is accused of using church leaders to lure in more than $5 million of investor funds, argued that the reduction would allow him to pursue a proper defense outside of a jail cell. The court denied the request, concluding that Reynolds is a flight risk and that his medical concerns and need for adequate resources to work on his defense can be addressed in jail.

   Kimberly Rothstein, 38, pleaded guilty to a federal conspiracy charge that she tried to conceal and sell more than $1 million of jewelry that was the proceeds of the Ponzi scheme run by her husband, Scott Rothstein. She faces a maximum of five years in prison, as do her two co-defendants Stacie Weisman, 49, and Scott Saidel, 45 (who was Kimberly’s lawyer), who have also pleaded guilty. Kim Rothstein and the others hid dozens of pieces of jewelry, including a 12-carat yellow diamond ring, gold bars, 10 luxury watches and an 18-diamond wedding band, and then attempted to sell them. Prosecutors say that they also tried to get Scott Rothstein to testify falsely in various civil cases about where the missing jewelry was located.

   Steven Steiner, 61, and Henry Fecker III, 59, await their fate as a jury deliberates the outcome of their criminal trial relating to allegations that they laundered millions of dollars in the Mutual Benefits Corp. Ponzi scheme. Mutual Benefits had sold $1.25 billion of life insurance policies held by people dying of AIDS, and investors lost $830 million in the scheme. Mutual Benefits was shut down in 2004, and a receiver administered the case. Separately, Steiner is awaiting another trial on charges accusing him and Joel Steinger of conspiring to defraud investors between 1994 and 2003. The president of Mutual Benefits, Peter Lombardi, previously pleaded guilty.

   David Tamman, former Nixon Peabody securities partner, was suspended from practicing law in California. Tamman was convicted on charges relating to the $20 million Ponzi scheme of Newpoint Financial Services Inc. run by John Farahi in Beverly Hills. The California State Bar automatically suspends any attorney convicted of "felonies involving moral turpitude." Tamman was found guilty on charges for backdating documents and lying about it during an SEC investigation. The Newpoint Financial scheme targeted the Iranian-American Jewish population in Los Angeles, who were told that their money would be used to purchase corporate bonds backed by the Troubled Asset Relief Program.

Anthony Vassallo, 33, pleaded guilty to a fraud charge in connection with his Ponzi scheme run though Equity Investment Management and Trading Inc. Vassallo promised investors profits of up to 36% per year through a computerized stock trading system. More than 300 customers, most of which were Mormons, invested a total of $83.3 million in the scheme. Co-defendant Kenneth Kenitzer, 66, pleaded guilty earlier and is awaiting sentencing. Several investors had been confronted by four of Vassallo's associates at gunpoint who identified themselves as federal agents and demanded over $378,000. Michael David Sanders, along with three accomplices, was later charged with conspiracy, impersonating a federal agent, and attempted extortion. The four were sentenced Friday, and each receiving probation.

   Frank Elroy Vennes, Jr., 55, of Florida, the former partner of Thomas Petters who helped raise millions of dollars for the Ponzi scheme, pleaded guilty for his role in the fraud. Vennes was scheduled to stand trial with James Nathan Fry, 59, the hedge fund manager who helped Vennes raise funds. The trial of Fry has been pushed back to an undetermined date. Vennes and Fry allegedly misled investors about the nature of their investments, failed to disclose Vennes' criminal, and did not report delays in interest payments as the scheme started to collapse in 2007. According to government calculations, Vennes and his company, Metro Gem, made more than $100 million in commissions over 15 years, and Fry collected $42 million over 10 years.

   Rodney Wagner, Roger Wagner and GID Group, Inc., all from Texas, were the subject of a CFTC order requiring them to pay $1.37 million in restitution to defrauded customers and a civil monetary penalty of about $1.05 million. The consent order finds that the defendants took at least $5.5 million from about 99 customers, that the Wagner brothers had represented that they were successful Forex traders who generated 6% returns per day, and that they promised that they could return principal plus 200% returns. The order also finds that the representations were false, that the defendants sustained consistent net trading losses, and that some of the stolen funds were used to pay their personal expenses and other pool participants’ purported returns.

   Michael Winans, Jr., 30, was sentenced to 13 years in prison in connection with his $8 million Ponzi scheme in which he promised nearly 1,200 victims they would receive 100% returns. He was the operator of the Winans Foundation Trust, which represented that it invested in crude oil bonds in Saudi Arabia. Winnans had pleaded guilty and was order to pay almost $4.8 million in restitution.

INTERNATIONAL PONZI SCHEME NEWS

Australia
   Wickham Securities was liquidated at a meeting for creditors. Wickham had raised funds from investors, many of which were retired and elderly, and then lent that money for property development, promising returns of up to 30%. Many people had invested in Wickham through Sherwin Financial Planners who provided investment advice. Sherwin has now also collapsed.

   David and Jacqueline Hobbs received the largest fine in the history of the Australian Securities and Investments Commission. They received a $500,000 fine in connection with their global Ponzi scheme that defrauded investors of more than $55 million. The scheme targeted more than 500 Australians and placed their money in 14 unlicensed funds, all located offshore in the Bahamas, Vanuatu and Hong Kong, among others. The court found that Mr. Hobbs’s conduct reflected a disregard for the interest of investors and found Mr. Hobbs "deliberately sought to put in place and have implemented a structure that was intended to avoid regulatory supervision (and hence would deprive investors of that safeguard)." A permanent ban has also been placed on Mr. Hobbs from managing corporations, and a 6 year ban was placed on Ms. Hobbs.

   Brian Wood, Jimmy Truong and Con Koutsoukos all pleaded guilty to charges in connection with a scheme called Integrity Plus Fund, which was one of David Hobbs funds and which raised more than $30 million from about 270 investors.

Germany
   Frankfurt Public Prosecution sent out 1,200 police officers and 15 public prosecutors to arrest Jonas Koeller, 31, and Stephan Schaefer, 33, and other suspects, to search their houses and premises of companies run by them and to seize all their belongings including some hundred parcels of land. More than 100 million euros ($124 million) was frozen. According to Frankfurt Public Prosecution, Koeller and Schaefer used Frankfurt based S&K companies, including Deutsche S&K Sachwert AG, and others to offer investors investments into the German real estate market promising 12% returns. News reports indicate a very lavish lifestyle of Koeller and Schaefer including high-end sports cars. Frankfurt Public Prosecution has started investigations into the affairs of lawyers, notaries, appraisers who had long standing relations with Schaefer and Koeller as well. It is to be expected that insolvency proceedings on the assets of the S&K companies will be opened shortly.

Report by Bernd H. Klose, www.raklose.de
Member of FraudNet, www.icc-ccs.org/home/fraudnet

Jamaica
   David Smith, who ran a $220 million Ponzi scheme that cheated thousands of Caribbean nationals in Jamaica and the Turks and Caicos, has asked for an early release from his 6½ year sentence in Grand Turk on the Turks and Caicos Islands. The Smith’s victims are less concerned about his early release than they are about what the government will do to secure the return of the millions of dollars lost by the victims. A confiscation order had been entered in the amount of $20.9 million, and Smith has until October 24, 2013 to pay that amount, otherwise he will serve an additional 8 years in prison by default. However, even if he is released, he still faces another 30 year sentence in Florida.

Philippines
   Kris Aquino, the sister of President Benigno Aquino, denied investing P50 million in the Ponzi-type scheme of Aman Futures Group founded by Manuel Amalilio. An estimated 15,000 victims lost P12 billion in the scheme. Amalilio is also known as Mohammad Kamal Bin Sa’ad and was arrested with a fake passport under the name of Manuel Karingal. President Aquino said that he expects Amalilio to be brought back to the Philippines to face trial.

South Africa
   The Financial Planning Institute, a South African organization for financial planners, is investigating whether any of its members breached that organization’s code of ethics in advising their client to invest in Relative Value Arbitrage Fund (RVAF). RVAF was a $245 million Ponzi scheme that defrauded 3,000 investors. The scheme was run by Herman Pretorius, who subsequently shot his partner, Julian Williams, and then committed suicide.

United Kingdom
   Jeremy Stone, the former manager of hedge fund Marble Bar Asset Management, lost his claims of negligence against NatWest and its employee Paul Amlin. Stone alleged that they failed to spot fraudulent activity of Saunders Electrical Wholesalers, which was run by Jolan Saunders. Stone had invested £20 million in the scheme. The court ruled that ruled Aplin had good reason to believe Saunders was running a legitimate business and "did not shut his eyes to the truth."

NEWSWORTHY LEGAL ISSUES IN PENDING PONZI SCHEME CASES

   Two legislators in New Hampshire are co-sponsoring a bill that would create a fund to pay restitution to victims of the state’s largest Ponzi scheme that was run by Financial Resources Mortgage Company. The bill would designate a percentage of fines collected by the Bureau of Securities Regulation, as well as the state Banking and Insurance departments, for the victims of FRM. FRM principal Scott Farah is serving a 15 year sentence, and co-defendant Donald Dodge was sentenced to 6½ years.

   Investor Denise Russelot filed a lawsuit against Focus Group Advisors, LLC, Larry Dearman, Marya Gray, Homer Fitzgerald, Jon Nettles, Daniel Wise, The Property Shoppe, Inc. and Bartnet, LLC in connection with her losses in what she alleges was a massive Ponzi scheme. Russelot alleged that Gray ran he scheme using various shell and alter ego companies, and that Gray convinced Dearman to use his Focus Group clients to fund the scheme.

   Daniel Stermer, the administrator over the state court proceeding for Global Bullion Exchange, filed a lawsuit against Wachovia Bank, which has been purchased by Wells Fargo Bank, alleging that the bank had failed to detect the fraud and failed to monitor the accounts.

   The trustee in the Bernard Madoff case, filed a motion seeking court approval to return another $505 million to victims of the Ponzi scheme. If the amount is approved, the total amount returned to victims would be $5.438 billion.

   The Second Circuit held that victims who lost money by investing in feeder funds are not entitled to recover for their losses in the same manner that direct victims of the Bernard Madoff Ponzi scheme. The court determined that "indirect" investors are not customers who can recover from the bankruptcy estate.

   In a separate opinion from the Second Circuit, investors were not permitted to pursue claims against Madoff’s brother, Peter, as well as Madoff’s son Andrew and the estate of his late son, Mark. The court said that allowing such claims to proceed would impede the trustee’s effort to maximize payouts from the estate.

   Bernie Madoff sent an email from prison, stating that his bank, JP Morgan, knew about the Ponzi scheme. Madoff also says that the feeder funds were involved and that the recipients of the monies paid to the feeder funds should be recovered by the Madoff trustee.

   The Department of Labor reached a more than $43 million settlement with Austin Capital Management Ltd. and its general partner Austin Capital Management GP Corp. that will compensate thousands or workers and retirees whose savings and health plans were harmed in the Bernard Madoff scheme. The Department of Labor investigation found that Austin Capital violated the Employee Retirement Income Security Act by allowing funds to invest the assets of ERISA-covered plans with Madoff through investments in the Rye Select Broad Market Prime Fund LP offered by Tremont Partners Inc, which was 100 percent invested with Madoff.

   The receiver for Management Solutions Inc. called off his proposed sale of property and advised the court that he would come up with another plan to liquidate the properties that are located in multiple states. A group of investors who had been opposing the bulk sale were pleased, believing that the properties will sell for more if marketed separately. The alleged Ponzi scheme was run by the owners of Management Solutions, Wendell Jacobson and Allen Jacobson, and it is alleged that the scheme took in about $200 million and defrauded 225 investors.

   Lincoln Financial Securities Corp. settled with FINRA over allegations of supervisory deficiencies in connection with the Kenneth Wayne McLeod Ponzi scheme run through F&S Asset Management Group and Federal Employee Benefits Group. FINRA noted several deficiencies, including that Lincoln Financial failed to place McLeod on heightened supervision, given that Lincoln Financial hired McLeod while a state securities regulator had an open investigation.

   Victims of Kenneth Wayne McLeod’s Ponzi scheme have filed suit against the United States for losses totaling $120.1 million. The 93 victims were active and retired government employees and law enforcement agents. The lawsuit seeks damages for the alleged negligence and wrongful acts of federal employees who endorsed McLeod to conduct retirement education and planning seminars for federal government and law enforcement employees. The victims allege that the U.S. failed to supervise McLeod to insure that the seminars did not provide specific financial investment advice, failed to properly vet and/or investigate McLeod and his company over a 20-year period and failed to adhere to the ethical rules that would have prevented the scheme. McLeod committed suicide in 2010.

   Bank of New York Mellon Corp. agreed to pay $114 million to settle investor claims in connection with the Medical Capital Holding Inc. Ponzi scheme. The settlement will resolve claims for BNY Mellon’s alleged failure to review MedCap’s dealings before disbursing investor funds to the company. The stolen money from the $1 billion Ponzi scheme went to pay for things like the purchase of failing hospitals, financing of a money-losing film about a Mexican little league team, the purchase of a 100-foot party yacht that cost $4.5 million, and an investment of $5 million into a company called EMark that supposedly specialized in internet porn, if in fact the company actually existed.

   The trustee in the Scott Rothstein case announced in his final liquidation plan that he expects that "payouts may fully compensate creditors holding general unsecured claims for their losses." The significant recoveries in this case are due in part to a proposed settlement with TD Bank for a proposed $72.45 million, and the trustee’s proposal that investors that have already recovered from TD Bank be barred from sharing in the distribution scheme until the total claims paid out reach 95% of losses. The total filed claims are $461,078,446.36 but may be reduced to $141 million through objections. The trustee is holding approximately $79.2 million in cash, which, when added to the $72.45 million TD Bank settlement, would allow 100% payment of the estimated claim total of $141 million. The trustee is also pursuing numerous clawback lawsuits against net winner investors and is in a dispute with the U.S. government over approximately$50 million in forfeited funds.

   The Trustee for Nevin Shapiro’s company, Capitol Investments USA Inc., which ran a $390 million Ponzi scheme, continued to prosecute a complaint filed against Marc Levinson and Shook, Hardy & Bacon in which allegations were made that Levinson and the firm helped Shapiro and his company to stay afloat financially even after they became aware of securities violations. The suit alleges that they "tacitly agreed with Capitol’s proliferation of its Ponzi scheme and Shook, Hardy & Bacon failed to ever deter Capitol from its additional borrowings."

   The NCAA’s University of Miami investigation relating to Nevin Shapiro is now being investigated itself. An investigation has revealed that the NCAA broke its own rules by using the information provided by Shapiro and paying his lawyer for it, even through the NCAA’s lawyers had advised against it. It is also alleged that Shapiro gave improper money and gifts to players and coaches and 3 assistant coaches are now being questioned about giving false of misleading information to authorities. Nevin’s lawyer says that "Nevin is extremely remorseful. That’s why he agreed to cooperate."

   The receiver and creditors committee in the Allen Stanford Ponzi scheme have sued Antigua, accusing it as serving as Stanford’s "blood brother" by providing the necessary assistance to allow the scheme to flourish. It is alleged that Antigua was a prime participant in the fraud, a co-conspirator, and the beneficiary of $90 million in loans from Stanford that were not repaid. A separate lawsuit was also filed against eight Caribbean banks. The lawsuits are seeking over $230 million in damages and punitive damages. A banking regulator, Leroy King, is facing criminal charges and has been accused of taking bribes from Stanford to falsify bank audits and to impede investigations by U.S. regulators.

   New documents were revealed in a lawsuit filed by victims in the Ephren Taylor Ponzi scheme against New Birth Missionary Baptist Church and Bishop Eddie Long of the Church that reflect that Bishop Long was warned about financial problems with Taylor before members of the congregation were convinced to invest more than $1 million in the scheme. An internal memo reflects that an unidentified caller informed Bishop Long’s assistant that he "did not want the church to be taken advantage of" and predicted that Taylor would "issue promissory notes to the congregation if allowed that gives him legal authorization to do what he wants and there will be no return on investment." Bishop Long reportedly introduced Taylor to the church members as "my friend, my brother, the great Ephren Taylor," but the Bishop did not himself invest with Taylor. The SEC says that Taylor and his company City Capital had raised about $11 million from churches across the country and that they issued promissory notes supposedly funding various small businesses and interests in "sweepstakes machines."

   The complaint filed by A.J. Feeley, Heather Mitts, Brent Celek and Kevin Curtis against Suntrust Bank Inc., Martin Kelly Capital Management LLC and William Crafton, for alleged misconduct relating to the Westmoore Management LLC Ponzi scheme, was sent to binding arbitration. The court concluded that the financial services agreements between the parties mandated a binding arbitration for the dispute. The plaintiffs are seeking to recoup their losses from the Ponzi scheme, alleging that the firms failed to vet the Crafton’s investment practices.

   The receiver of ZeekRewards filed a quarterly report in the case with over 1 million victims. The report reflects that the receiver is holding approximately $310 million, and that at least $295 million may have been transferred to about 80,000 net winners and subject to possible fraudulent transfer claims. The receiver has expressed his intent to pursue both domestic and foreign defendants.

   Also in the ZeekRewards proceeding, the judge overseeing the case refused to appoint a separate examiner, who was proposed by net winner investors to supervise the court-appointed receiver’s efforts. The court noted that it would be impossible for an examiner to represent the interests of both net winners and net losers and that it would result in a duplication of efforts being made by the receiver.



Tuesday, February 26, 2013

First NAFER Newsletter Discusses Receivers and the In Pari Delicto Doctrine

Posted by Kathy Bazoian Phelps

   The National Association of Federal Equity Receivers (NAFER) just published its first newsletter, called "The Receiver." It is available here.

   Be sure to check out my article, "Receivers and the In Pari Delicto Doctrine." Michael D. Napoli also has a great article on "Avoiding the Automatic Turnover of Assets Required by Section 543 of the Bankruptcy Code."

   If you're not already familiar with it, you may want to check out the organization at www.naferfoum.org. NAFER's upcoming conference in Chicago in September is anticipated to be a terrific networking and educational opportunity for those involved in equity receivership cases.

Monday, February 25, 2013

Return on Equity or Interest on a Loan? It Doesn't Matter When a Ponzi Scheme Unravels


Posted by Kathy Bazoian Phelps

   In the consolidated bankruptcy proceeding of Frederick Darren Berg and the Meridian Funds, the trustee filed several fraudulent transfer actions. In one of them, against Jack W. Brown and Margaret A. Heftel, the trustee claimed that fictitious interest payments were constructive fraudulent transfers. Calvert v. Brown (In re Consolidated Meridian Funds), 2013 Bankr. LEXIS, 675 (Bankr. W.D. Wash. Feb. 19, 2013). The defendants had made loans to the Meridian Funds in exchange for promissory notes promising interest between 9.5% and 12.5% per annum.

   Brown and Heftel filed a motion for summary judgment. The court had previously denied a different defendant’s motion for summary judgment, where, like here, the defendants had received back more than their initial investment and it was recovery of the profits that was at issue. Brown and Heftel argued a different twist on the analysis of whether the debtors received reasonably equivalent value in exchange for their interest payments.

   The court had previously ruled in Calvert v. Foster Radford that interest payments were not in "satisfaction of an antecedent debt within the meaning of either the state or federal fraudulent conveyance statutes, and therefore did not constitute reasonably equivalent value." Id. at *10. In their motion, Brown and Heftel contended that the court did not consider the argument that in analyzing the issue of reasonable equivalent value, a lender should be treated differently than an equity investor. "They argue that a debtor’s repayment of an equity investment would not qualify as satisfaction of an antecedent debt under the state UFTA, whereas the debtor's repayment of a loan with reasonable interest should qualify as satisfaction of an antecedent debt." Id. at *11.

   The court first analyzed the split of authority on whether reasonably equivalent value can ever be exchanged in connection with the payment of interest in a Ponzi scheme case. It noted that most courts find that "any return to a lender or investor in a Ponzi scheme in excess of the principal investment will not be treated as value, and therefore cannot be counted in determining whether the return was ‘reasonably equivalent.’" Id. at *14–15; see also, Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008), In re United Energy Corp., 944 F.2d 589, 596 (9th Cir. 1991). On the other hand, the court considered the few decisions that have held that "commercially reasonable interest on an enforceable promissory note should be treated as payment on an antecedent debt and therefore not be recoverable as a fraudulent conveyance." Id. at *13-14 (citing In re Unified Commercial Capital, Inc., 260 B.R. 343 (Bankr. W.D.N.Y. 2001); In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002).

   The court then accurately captured the struggle in trying to do equity in these circumstances:
There is no question that the courts have struggled with the differing facts in these cases, where the consequences of the scheme deprive some investors of their life savings and render other investors defendants in lawsuits where significant sums of money, long since paid to them, are subject to recapture. Acknowledging these harsh results, the Ninth Circuit adopted a rule intended to even out the results as between investors who get paid and those who do not. Investors who get paid are protected by the various statutes of limitation; they may keep those payments made to them outside the statute of limitations, but they must share the pain by giving up anything they received in excess of their investment within the applicable statute of limitations. The case law reflects that the courts are not in agreement as to how the pain should be shared in these unfortunate cases.Meridian at *16-17.

   The court then engaged in analysis of other cases cited by the defendants, distinguishing each of them on the following basis:
  • In re Image Masters, Inc., 421 B.R. 164 (Bankr. E.D. Pa. 2009): Lending institutions had received payments on homeowner loans as part of the scheme, but the court found that none of the debtors had a direct relationship with the lenders. Rather, homeowners refinanced their homes directly with the lenders who took mortgages in the homes, and the homeowners then separately contracted with the debtors regarding wraparound mortgages on their homes. "The court concluded that because the debtors’ payments to the lenders reduced the debtors’ debt to the homeowners, the debtors received ‘value’ for those payments, and that because the reduction in the debt was dollar-for-dollar, it was also equivalent." Meridian at *21.
  • In re Financial Federated Title & Trust, Inc., 309 F.3d 1325 (11th Cir. 2002): This case deals with the trustee’s claim to recover commissions paid to a former employee of the debtor. The "court followed In re Universal Clearing House Co., 60 B.R. 985 (D. Utah 1986), in concluding that the determination of ‘value’ should focus on the value of the goods and services provided rather than the impact the goods and services had on the bankrupt entity (i.e., deepening insolvency and furtherance of the Ponzi scheme)." Meridian at 21.
  • In re M&M Marketing, LLC, 2013 WL 152526 (Bankr. D. Neb. Jan. 15, 2013): The court noted that this court "cited Donell with approval, but noted that other courts, in the right circumstances, might find the repayment of interest equivalent value, citing Carrozzella. The facts in the case before the M&M court, however, did involve what the court thought was an excessively high rate of interest, 25% in 90 days." Meridian at *22.
   In the Meridian case, Brown and Heftel argued that they are not were not "investors in the equity sense" but rather were more like traditional lenders. Id. at *18-19. The court noted, however, that "The notes attached to the Brown Declaration and the Heftel Declaration, however, look more like investments than traditional loans" and set forth a few facts in this case which informed that conclusion. Id. at *19. The court found:
  • "The notes refer to disclosure packages and subscription agreements, which are normally associated with investments rather than commercial loans." Id.
  • "The complaints in these cases allege that the sole business of the Meridian Funds was to offer and sell promissory notes to investors and that investors were told that the sole purpose of the investment was to enable the Meridian Funds to invest on their behalf in seller-financed real estate contracts, hard money loans, real estate and mortgage-back securities." Id.
  • "Investors like Mr. Brown and Ms. Heftel were promised rates of return on their investments in the form of interest payments." Id.
   Accordingly, the court denied the defendants’ motion for summary judgment.

   At least in the Ninth Circuit on this issue, the label doesn’t matter, and recipients of payments in a Ponzi scheme are more simply characterized as net losers or net winners. As the Meridian court noted: The Ninth Circuit "has not adopted a rule which treats victims of a Ponzi scheme differently depending upon whether their investment can be characterized as a financial investment, equity investment or loan." Id. at *19.

Friday, February 22, 2013

Yet Another Ponzi Scheme Victim's Negligence Suit Against the SEC Fails

Posted by Kathy Bazoian Phelps

   Understandably, defrauded victims of Ponzi schemes are angry – angry at the perpetrators, angry at everyone associated which the scheme, and angry at the government for failing to stop the scheme before they were victimized and lost their life savings. Occasionally that anger at the government is expressed in a suit against the government. The Ponzi Scheme Blog has been following these cases (see the September 11, 2012 blog: Finger-Pointing at the SEC: Whose Fault Is It That Ponzi Schemes Thrive?) and, so far, no case against the government on this basis has succeeded.

   The latest to fail is Dichter-Mad Family Partners, LLP v. United States, 707 F. Supp. 2d 1016 (C.D. Cal. 2010), aff’d, 2013 U.S. App. LEXIS 2900 (9th Cir. Feb. 12, 2013). In that case, the plaintiffs, who were investors in Madoff’s Ponzi scheme, filed a claim for damages under the Federal Tort Claims Act ("FTCA"), asserting that the Securities and Exchange Commission was negligent in failing "to terminate Madoff's Ponzi scheme despite its multiple opportunities to do so." The fifty page complaint reviews in detail the warning signs about Madoff that the SEC had and its several failed investigations of him. The complaint also incorporates by reference the SEC Office of Inspector General’s 450 page Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme--Public Version, released in August 2009.

   The FTCA, 28 U.S.C. § 1346(b), grants the federal courts jurisdiction over claims:
for injury or loss of property, or personal injury or death caused by the negligent or wrongful act or omission of any employee of the Government while acting within the scope of his office or employment, under circumstances where the United States, if a private person, would be liable to the claimant in accordance with the law of the place where the act or omission occurred.   The district court, however, readily dismissed the claim, concluding that it was barred by the "discretionary function exception" of the FTCA. Under this exception in 28 U.S.C. § 2680(a), the government is not to be liable for:
Any claim based upon an act or omission of an employee of the Government ... based upon the exercise or performance or the failure to exercise or perform a discretionary function or duty on the part of a federal agency or an employee of the Government, whether or not the discretion involved be abused.   In Dichter-Mad Family Partners, the district court found that "the alleged wrongs were done in the course of the SEC’s exercise of its discretion, both in terms of conducting its investigations and deciding whether or not to bring enforcement proceedings." Id. at 1035. For example, Section 21 of the Securities and Exchange Act of 1934, states, "The Commission may, in its discretion, make such investigations as it deems necessary to determine whether any person has violated, is violating, or is about to violate any provision of this chapter, [or] the rules or regulations thereunder . . ." 15 U.S.C. § 78u (emphasis added). The district court further found that the plaintiff’s conclusory allegations had failed to rebut the presumption that discretionary function exception applied. Id. at 1041.

   The Ninth Circuit affirmed in a per curiam decision, adopting most of the district court’s "comprehensive and well-reasoned opinion" as its own. Therefore, these Madoff victims are left without a remedy against the government despite findings of the SEC Inspector General that the agency had missed several opportunities over the years to stop Madoff’s fraud.

   As noted, however, this is not the first such decision dismissing a negligence suit filed by Madoff victims against the SEC. See Donohue v. United States, 870 F. Supp. 2d 97 (D.D.C. 2012); Baer v. United States, 2011 U.S. Dist. LEXIS 141243 (D.N.J. Dec. 8, 2011); Molchatsky v. United States, 778 F. Supp. 2d 421 (S.D.N.Y. 2011).

   Similarly, in the Allen Stanford Ponzi scheme, victims were also unsuccessful in pursuing their negligence claims against the SEC. See Robert Juan Dartez, LLC v. United States, 824 F. Supp. 2d 743 (N.D. Tex. 2011).

   As reported in the September 11, 2102 blog, one case, Zelaya v. United States, 2012 U.S. Dist. LEXIS 127233 (S.D. Fla. Sept. 7, 2012), does offer a glimmer of hope to defrauded victims. In that case, the district court dismissed all of the plaintiffs’ negligence claims except the claim that the SEC violated its nondiscretionary duty to report Stanford to the Securities Investor Protection Corporation, as required by 15 U.S.C. § 78eee(a)(1). A review of the docket in that case shows that it is now in the discovery phase. No trial date has been set.

   These cases raise the question of what is fair when the government is negligent? As a policy matter, should the FTCA be changed to require the government to compensate Ponzi scheme victims when it negligently stops a scheme later than it should have if it had exercised due care? If Congress does decide to do that, which seems highly unlikely, Congress should then also increase the SEC’s resources, both for investigating Ponzi schemes and for paying victims’ claims. The societal cost of increased resources for better government due diligence may ultimately be far less than the cost to victims from losses from these types of fraudulent schemes.

Monday, February 4, 2013

Ponzi Scheme Victims and SLUSA: The Supreme Court to Decide What Claims Can Proceed

Posted by Kathy Bazoian Phelps

   Defrauded investors in a Ponzi scheme have a few choices when the scheme goes bust. They can wait for a distribution from the insolvency proceeding, or they can take matters into their own hands and form a class to sue third parties for their damages. However, the Securities Litigation Uniform Standards Act ("SLUSA") can impose a formidable barrier for those types of class action suits.

   SLUSA states, "No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security." 15 U.S.C. § 78bb(f)(1)(A).

   The Supreme Court has agreed to hear an appeal in three related cases in the Allen Stanford Ponzi scheme case on the significant question of when SLUSA precludes investors’ state law claims for relief against third parties.

   The decision that the Supreme Court will review is the Fifth Circuit’s decision in Roland v. Green, 675 F.3d 503 (5th Cir. 2012). The district court had before it three state class actions to recover damages. In these suits, investors asserted a range of claims under Texas and Louisiana law against a number of third party defendants, including two law firms, Proskauer Rose and Chadbourne & Parke, as well as an insurance brokerage, Willis of Colorado, Inc. These are the parties that eventually petitioned the Supreme Court to hear the case.

   In their complaints, the plaintiffs claimed that they were misled into buying Stanford’s International Bank’s certificates of deposit by several misrepresentations, including that SIB’s assets were "invested in a well-diversified portfolio of highly marketable securities issued by stable national governments, strong multinational companies, and major international banks." The plaintiffs alleged that law firms aided and abetted Stanford’s fraud.

   The defendants moved to dismiss under SLUSA, asserting that the plaintiffs were claiming misrepresentations of material facts in connection with the purchase of a "covered security." The district court agreed and dismissed.

What Does "In Connection With" a "Covered Security" Mean?

   The district court found that the SIB CDs themselves were not "covered securities" within the meaning of SLUSA because SIB never registered the CDs, nor were they traded on a national exchange. Nevertheless, it held that the alleged misrepresentations were "in connection with" the purchase of a "covered security," finding that:
  • The plaintiffs’ "purchases of SIB CDs were ‘induced’ by the misrepresentation that SIB invested in a portfolio including SLUSA-covered securities"; and
  • The plaintiffs’ allegations "reasonably imply that the Stanford scheme coincided with and depended upon the Plaintiffs’ sale of SLUSA-covered securities to finance SIB CD purchases."
   On appeal, the Fifth Circuit reversed and reinstated the plaintiffs’ state law-based class action suits. Roland, 675 F.3d at 520. It reviewed the substantial conflicts in the standards that the other courts of appeals had adopted on the issue of when a misrepresentation is "in connection with the purchase or sale of a covered security." The Fifth Circuit agreed with the standard that the Ninth Circuit had adopted in Madden v. Cowen & Co., 576 F.3d 957 (9th Cir. 2009): "Accordingly, if Appellants’ allegations regarding the fraud are more than tangentially related to (real or purported) transactions in covered securities, then they are properly removable and also precluded." Roland, at 520.

   Applying that standard, the Fifth Circuit concluded that the plaintiffs’ "references to SIB’s portfolio being backed by ‘covered securities’ to be merely tangentially related to the ‘heart,’ ‘crux,’ or ‘gravamen’ of the defendants’ fraud." Id. at 521 (footnotes omitted). Rather, the court found that the "heart, crux, and gravamen of their allegedly fraudulent scheme was representing to the Appellants that the CDs were a ‘safe and secure’ investment that was preferable to other investments for many reasons." Id. Therefore, the Fifth Circuit rejected the district court’s rationale that the plaintiffs’ purchases of SIB’s CDs were induced by the misrepresentation that SIB invested in a portfolio that included SLUSA-covered securities.

   The district court had also concluded that the claimed fraud was "in connection with" the sale of a security because to fund their investments in SIB’s fraudulent CDs, some plaintiffs had sold their existing, unrelated securities. The Fifth Circuit also rejected that rationale, finding that Stanford’s scheme was focused not on persuading the plaintiffs to sell their securities, but on selling the fraudulent CDs. Id. at 523.

The Split in the Circuits

   The standard adopted by the Fifth and Ninth Circuits - the "more than tangentially related" test - is a narrow test, which results in the dismissal of smaller group of these class action suits against third parties in Ponzi scheme and other fraud cases.

   On the other hand, the tests adopted by the Second, Sixth, and Eleventh Circuits are broader and require the dismissal of a larger group of these cases. Although these courts articulate their tests slightly differently, each certainly would require the dismissal of the three cases in Roland v. Green.

   In Romano v. Kazacos, 609 F.3d 512, 522 (2d Cir. 2010), the Second Circuit held that the SLUSA requirement is met "where plaintiff’s claims ‘necessarily allege,’ ‘necessarily involve,’ or ‘rest on’ the purchase or sale of securities." (This was the test on which the district court relied in dismissing Roland v. Green.)

   In Segal v. Fifth Third Bank, N.A., 581 F.3d 305, 310 (6th Cir. 2009), the Sixth Circuit held that SLUSA’s "in connection with" requirement is satisfied when the fraud "coincide[s] with" or "depend[s] upon" securities transactions. The Sixth Circuit further held that SLUSA "does not ask whether the complaint makes ‘material’ or ‘dependent’ allegations of misrepresentations in connection with buying or selling securities." Id. It only "asks whether the complaint includes these types of allegations, pure and simple." Id. at 311.

   In Instituto De Prevision Militar v. Merrill Lynch, 546 F.3d 1340, 1349 (11th Cir. 2008), the Eleventh Circuit held that a misrepresentation is made "in connection with" a covered securities transaction so long as either an alleged misrepresentation about a covered securities transaction "induced [plaintiff] to invest with [defendant]," or the misrepresentation "coincided and depended upon the purchase or sale of securities."

Supreme Court Precedent

   The Supreme Court’s decision will likely turn on its interpretation of its own precedent in SEC v. Zandford, 535 U.S. 813, 824 (2002), and Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006).

   In Zandford the issue was when a misrepresentation is "in connection with" a securities sale, as required to state a claim under § 10(b). The Court held that it is sufficient if the misrepresentation "coincides" with the sale or purchase of a covered security. However, the Court cautioned that "the statute must not be construed so broadly as to convert every common-law fraud that happens to involve [covered] securities into a violation of § 10(b)." 535 U.S. at 820.

   In Dabit, the Court addressed the SLUSA issue - when is a plaintiff’s claim of a misrepresentation "in connection with the purchase or sale" of a covered security? In that case, the plaintiffs alleged in their state law fraud suit that the defendants’ misrepresentations induced them to hold their securities. They had neither purchased nor sold a security as a consequence of the alleged misrepresentations. The Supreme Court nevertheless held that SLUSA bars their claims. It held that the SLUSA phrase "in connection with the purchase or sale of a covered security" must be given the same "broad construction" as the nearly identical "in connection with" language in § 10(b) itself, which requires only that the "fraud alleged ‘coincide’ with a securities transaction—whether by the plaintiff or by someone else." Dabit at 74, 85.

Significance of the Outcome of Roland v. Green

   The outcome of Roland v. Green in the Supreme Court will directly impact the availability of investors’ remedies in many Ponzi scheme cases, where the perpetrator’s promise to invest in securities turns out to be wholly illusory. For example, as we know, Bernard Madoff also falsely promised securities investments. Madoff investors have the additional issue that many of Madoff’s victims invested not with him directly, but with feeder funds who in turn invested with Madoff.

   So, how will the Supreme Court resolve the conflict in the circuits on this important issue?
  • Which test will it adopt?
  • Will Ponzi scheme victims be denied their state law fraud claims that are based on false promises to invest in covered securities?
  • Will their claims stand if they invested in feeder funds that in turn invested with a schemer who falsely promises to invest in covered securities?
   This issue, along with other statutory and securities issues, are covered in depth in chapter 10 of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes (LexisNexis® 2012). Go to: www.theponzibook.com for more information.