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

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about 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

Monday, June 30, 2014

June 2014 Ponzi Scheme Roundup

Posted by Kathy Bazoian Phelps

     Below is a summary of the activity reported for June 2014. The reported stories reflect: 7 guilty pleas or convictions in pending cases; over 139 years of newly imposed sentences for individuals involved in Ponzi schemes; at least 8 newly discovered schemes allegedly involving over $147 million; and an average age of approximately 52 for the alleged Ponzi schemers in the stories reported. 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.

     Thomas Abdallah aka Tom Abraham, 49, Kenneth Grant, 66, Mark M. George, 56, Jeffrey L. Gainer, 49, Nancy Gainer, 50, Jerry A. Cicolani Jr., 45, and Kelly Hood, 35, were charged in a complaint filed by the SEC with operating a $20 million Ponzi scheme involving a fictitious oil and fuel-trading business. The complaint also named KGTA Petroleum Ltd., NATG, LLC and Turnbury Consulting Group LLC. Investors were allegedly told that they could earn 2% to 4% monthly with no risk by buying notes in KGTA. The scheme allegedly defrauded 47 people.

     Russell Adler, 52, was sentenced to 2½ years in prison after he pleaded guilty a few months ago to charges relating to the Ponzi scheme run by Scott Rothstein and through their firm, Rothstein Rosenfeldt Adler. Adler pleaded guilty to charges that he violated federal campaign finance laws.

     Fuad Ahmed and his company, Success Trade Securities, were barred from the securities industry by FINRA for allegedly running a Ponzi scheme that defrauded 59 people, including current and retired NFL and NBA players. FINRA ordered Ahmed to pay $13.7 million to investors.

     Robert J. Andres and Robert Holloway were hit with a $44 million judgment in connection with a Ponzi scheme run through Winsome Investment Trust and U.S. Ventures. The CFTC obtained a default judgment in connection with its lawsuit alleging that Andres and Holloway took in at least $50 million from 243 people to invest in a commodity futures pool. Among other things, the two claimed to have a 40% interest in a "Safekeeping Receipt" from the Union Bank of Switzerland, which supposedly represented 500 metric tons of gold having a face value of $7.7 billion.

     Brian Arias, 41, pleaded guilty to charges in connection with the Nicholas Cosmo Ponzi scheme run through Cosmo’s Agape companies. Arias admitted that he knew he was lying to investors about the way their money was being invested and the promised high returns. Cosmo promised investors returns of up to 80%, and the scheme took in $400 million from 5,000 investors. Cosmo is serving a 25 year prison sentence.

     Aldo Joseph Baccala, 73, was sentenced to 20 years in prison and ordered to pay $6.4 million in connection with a $17 million Ponzi scheme run through Baccala Realty that defrauded more than 50 investors. Baccala had promised investors returns of 12% on notes for investments in properties such as assisted living facilities, a car wash, and other businesses.

     Michael Balboa, 45, was sentenced to 4 years in prison in connection with a $390 million Ponzi scheme that Balboa ran through Millennium Global Investments. Balboa provided fake valuations to inflate month-end market prices on Nigerian warrants.

     Alice Belmonte, 47, was sentenced to 3 to 9 years in prison in connection with her $4 million Ponzi scheme that defrauded more than 10 victims. Belmonte is a disbarred lawyer who had lured in investors to buy foreclosed properties and promised them large returns.

     Janet Brown was sentenced to one year in prison on charges of bankruptcy fraud relating to her late husband, Jack Brown, and his $12 million Ponzi scheme run through Brown’s Tax Service. She had pleaded guilty to charges that she withheld $25,000 in jewelry from the bankruptcy trustee.
     Edwards Exploration LLC was sued by a group of investors alleging that the company defrauded them in a $12 million Ponzi scheme. The company’s now-deceased founder, Spencer Edwards, persuaded the investors to invest in oil and gas interests.

     Fred Davis Clark Jr., 56, and Cristal R. Clark aka Cristal Coleman Clark, 41, former executives of Cay Clubs, were arrested in connection with what had been an alleged $300 million Ponzi scheme. The SEC’s civil enforcement action against Cay Clubs was recently dismissed on statute of limitations grounds, but the Clarks were arrested in Honduras on conspiracy and obstruction charges and brought back to the U.S. Cay Clubs lured investors in the residential real estate scheme by promising 15% annual returns to be generated by refurbishing low end properties into five star resorts.

     Jenny Coplan, 55, pleaded guilty to charges in connection with a $4 million Ponzi scheme run through Immigration General Services LLC. Coplan promised investors more than 60% per year for investing in federal bail and immigration bonds. Coplan provided false financial information and promised that investors’ funds were insured by the Federal Deposit Insurance Company.

     Shawn Kristi Dicken, 40, was sentenced to 140 months to 20 years in prison and ordered to pay restitution in an amount estimated to be $1.5 million for her role as the lead salesperson for The Diversified Group Advisory Firm LLC. Dicken had marketed investments to investor, representing their investments were without risk, completely liquid, and had a guaranteed rate of return between 9.5% and 10.44%. The Ponzi scheme was allegedly operated by Joel Wilson, who was arrested in Germany after fleeing the country following charges against him.

     James Ronald Donahoo II, 36, pleaded guilty to charges in connection with a Ponzi scheme that he ran through Paradigm Investing, Inc. Donahoo had promised investors returns of 3% per month by investing in bridge loans. He raised at least $2.5 million from investors. Instead of investing in loans, he used $1.5 million to fund businesses, to purchase $11,000 worth of fur coats, travel, jewelry and a Mercedes Benz. Following the scheme’s collapse, Donahoo began traveling around the country by bicycle to promote philanthropic causes, referring to himself as the “Bamboo Cyclist.”

     Henry Millward Fisher, Jr. 60, was sentenced to 25 years in prison, with 5 years suspended, in connection with a $1 million Ponzi scheme that defrauded 23 investors and involved 6 properties. Fisher had previously served jail time in the 1990s for defrauding investors of more than $7 million in a similar Ponzi scheme.

     Claus Foerster was barred from the securities industry by FINRA after FINRA accused him of stealing nearly $3 million from 13 clients. Foerster allegedly solicited investments through his fund known as S.G. Investments, which was not actually an investment fund but a bank account controlled by Foerster.

     Richard Freer’s attorney sought the release of about $20,000 of the $50,000 cash that Freer has to pay back $7.8 million to his 90 defrauded victims. Freer’s attorney asked to be paid and argued that “The uses of the defendant’s funds for payment of counsel fees will not . . . materially affect his ability to make restitution in these matters.” The lawyer’s request was denied, and the court found that the remaining funds would instead go to Freer’s victims. Freer, 68, is currently serving a 12 to 30 year sentence after pleading guilty to operating a $10.1 million Ponzi scheme.

     Michael Frew was permanently barred from the brokerage industry in connection with allegations that he was running a Ponzi scheme. Frew represented that he would invest with a real estate developer to rehabilitate properties in areas hit by natural disasters. He promised investors returns of 10% to 14% annually. Frew had refused to cooperate with the FINRA investigation which was opened one month after Frew had resigned from Wells Fargo Advisors following that firm’s investigation into whether he had received funds from customers. Frew ultimately consented to FINRA’s findings without admitting or denying the charges.

     Tate George’s, 46, sentencing was delayed for a few months to allow the lawyers to determine how much money the victims of the real estate Ponzi scheme lost. The figure has been estimated at about $2 million, but the government is claiming that the amount is higher.

     James D. Helgeson was fined by Montana’s Commissioner of Securities and Insurance and acknowledged that he participated in TelexFree. Helgeson was also a former pitchman for ZeekRewards. Helgeson must notify Montana for the next five years “prior to his participation in any multilevel distribution company.”

     Thomas Kimmel, 68, was convicted on charges that he ran a Ponzi scheme through his company, Sure Line Acceptance Corporation, which claims to be the financing wing of Automacion, a used car company. Kimmel made false promises to investors who he found through his organization, Faithful Stewards, which offered “debt-free conferences” and “God’s Plan for His Money Conferences” to churches.

     Paul Konigsberg, 78, pleaded guilty to charges that he assisted in the Bernard Madoff Ponzi scheme. Konigsberg, who was Madoff’s former accountant, fabricated records to cover up the Ponzi scheme and was charged with conspiracy, falsifying records of a broker-dealer, fabricating records of an investment adviser, and falsifying statements to the U.S. about employee-benefit plans. Konigsberg told the judge, “I was not aware of Madoff’s horrific and evil Ponzi scheme . . .” But he admitted that he knew that some of the investors’ account statements had been altered and that he used those when filing their taxes.

     Robert P. McDermott Sr., 52, was sentenced to 3 years in prison in connection with a Ponzi scheme in which he stole at least $270,000 from about 50 clients. McDermott had represented that he would place customer funds paid in advance for funeral services into insurance policies, annuities or trusts, but he failed to do so. Insurance companies honored some of the policies even though McDermott never paid the premiums, leading to recovery of about $110,000.

     Patricia S. Miller, 67, was arrested on charges that she orchestrated a Ponzi scheme in which she used her position as a financial advisor to lure in investors. She allegedly promised them high returns if they invested in investment clubs called KS Investment and Buckharbor.

     Earl Abdulmalik Mohammed, 47, was sentenced to 9 years and ordered to pay restitution in the amount of $6.5 million in connection with a $6 million Ponzi scheme that he ran through Global Gold and Metals Trading. Mohammed lured investors to buy precious metals online by selling products below market value but then would fail to deliver the package, claiming that the Postal
Service had lost it.

     Michael Morawski lost his appeal of his 10 year prison sentence in connection with a $16.8 million Ponzi scheme. U.S. v. Morawski, 2014 U.S. App. LEXIS 10968 (7th Cir. 2014). The court rejected Morawski’s claim that his sentence was based on an inflated estimate of losses

     Robert Palmer, 45, and Mark Driver, 50, pleaded guilty to charges that they ran a $3 million Ponzi scheme through Princeton Partnership. They lured in funds from elderly investors for the purpose of real estate investments and life insurance annuities, but kept the money for their personal use.

     Rudolf “Rudi” Pameijer, 63, was sentenced to 18 years in prison and ordered to pay $1.8 million in restitution for his role in a Ponzi scheme that defrauded 24 investors. Pameijer sold fraudulent investment contracts and securities in the form of promissory notes through his company, Plan America LLC, and promised returns of 3% to 15% allegedly based on the performance of foreign markets. The scheme also involved Pameijer’s daughter, Lindsay Pameijer, 34, and Ryan W. Koester, 42, who ran Rykoworks Capital Group LLC. Pameijer spent the investors' funds on his own lavish lifestyle include cars, a boat, his son’s college tuition and his daughter’s wedding and honeymoon in St. Lucia.

     James M. Peister, 62, was charged in connection with an alleged $17 million Ponzi scheme that defrauded at least 74 investors through several commodity pools, including Northstar International Group, Inc., North American Globex Fund, L.P., and North American Globex Group, Inc. Peister had been charged by both the SEC and the CFTC in 2011 but had settled both of those cases. Peister pleaded not guilty to the recent criminal charges.

     Dee Allen Randall, 63, of Utah, was indicted on charges that he ran a Ponzi scheme through his businesses, including Horizon Mortgage & Investment, Horizon Financial & Insurance Group, and Horizon Auto Funding, that defrauded about 700 people out of at least $72 million. Randall promised investors returns of 9% to 17% on their investments in real estate, auto leases and insurance products.

     Richard Reynolds aka Richard Adkins, 53, was sentenced to 20 years in prison following his conviction on charges that he defrauded more than 141 investors out of $5.38 million, using his connections with ministers, pastors and other religious leaders to recruit new investors. The scheme was run through his companies, United Consultant Investment Corp., Buffalo Exchange, and Buffalo Extension, and Reynolds promised investor quarterly returns of 100%.  Following the sentencing, Reynolds said that he “will fry this court.”

     Brian C. Rose aka John Hankins, 34, Brent Lovall, 30, and Ray Spears aka Brock Hamilton, 44, were charged with defrauding 160 investors out of $15 million. Rose had operated under the name Earth Energy Exploration and then renamed the business after it came under investigation New Century Coal, supposedly mining blue gem coal. Rose pleaded not guilty to the charges.

     Stuart Rosenfeldt, 59, former partner of Scott Rothstein, pleaded guilty to bank fraud, campaign finance violations and financial irregularities in connection with their firm, Rothstein Rosenfeldt Adler. Rosenfeldt was never charged with having knowledge of the Ponzi scheme itself but was accused of making hundreds of thousands of dollars of illegal campaign contributions and using law enforcement to force a prostitute and her boyfriend to leave town before the prostitute exposed her relationship with Rosenfeldt. Rosenfeldt is the fifth former lawyer of the Rothstein law firm to be convicted.

     Ephren Taylor II, 31, was arrested on charges that he defrauded investors out of more than $5 million. The charges allege that Taylor, through his company City Capital Corporation, and the company’s former COO Wendy Connor, “participated in a conspiracy to defraud investors.” Taylor allegedly pushed churchgoers to invest in small businesses he knew wouldn’t be profitable, and also offered investments in “100 percent risk free” sweepstakes machines, or computers with games where players can win cash prizes. The returns promised range from 12% to 20% on the business investments and up to 300% in the sweepstakes machines.

     TelexFree had a bankruptcy trustee appointed, and the trustee is seeking records from the lawyers and other professionals previously working with Telexfree since the books and records of the company were previously seized by the government along with all of the company’s bank accounts. The Nevada Public Utilities Commission rejected the company’s application to become a telecom provider. James Merrill was freed on bail under tight restrictions.

     Deepal Wannakuwatte, 63, and his company International Manufacturing Group, filed for bankruptcy protection as part of his plea agreement with federal prosecutors. Wannakuwatte listed $134 million of debt and $15.9 million in assets on his individual schedules. He agreed to forfeit his real estate and bank accounts and to surrender $8 to $12 million in tax refunds. Wannakuwatte claimed he had $100 million worth of contracts to sell latex gloves to veterans hospitals, but in fact only had $25,000 per year.


     Joe Camilleri sued the Legal Services Board for more than $140,000 seeking payment for funds stolen from him by lawyer Philip Linacre, 61, in connection with a $12 million Ponzi scheme. Linacre had promised returns of between 13% and 23%. Camilleri has sued the Legal Services Board which has refused to refund his money out of the Legal Practitioners Fidelity Fund.

     Ronald David Williams and Gary David Maile, former directors of Selection One Finance Pty Ltd., were sentenced to 4 years and 3 months each after pleading guilty to breaches of their director duties. Williams and Maile had promised investors returns of 3% per month.

     Chi-Ho Chan aka Moses Chan, 38, was charged with two counts of fraud in connection with an alleged scheme targeting Calgary’s Asian community that brought in more than $6 million. Chan operated an investment and immigration scheme. The investment scheme involved promises in a share of profits from the sale of electronics imported from Hong Kong and sold in the U.S.

     Investors in the Rienzi “Joe” Silva Ponzi scheme have filed a £1.2m lawsuit against the solicitors that provided conveyancing services to Abbey Brokers. The lawsuit alleges that Barrington Charles Edwards and Company is liable for the losses as it breached its fiduciary duty and client trust by making payments into third party accounts used in Silva’s fraud.

     A fraud investigation was opened against a number of companies which form part of the Rican Group after complaints were received about an alleged Ponzi scheme. Richard Cannon, 54, was charged with two counts of fraud in connection with the alleged scheme.

     Defrauded investors in the Ponzi scheme run by John Anderson, Kenneth Peacock and Kautilya Nanda Pruthi were invited to claim their share of the £914,000 "likely" available for distribution by the Financial Conduct Authority. The scheme had offered investors returns of up to 20% per month on short-term fixed deposits. The money to be distributed represents about 1% to 2% of the money lost.

     The German Federal Finance Court issued a decision that any payments received from a Ponzi scheme, or payments that were reinvested, are taxable as investment income even if the Ponzi scheme fails. See File No. VII R 25/123. Reported by Bernd Klose, http://www.raklose.de/.

     The German Federal Court issued a decision that victims of Ponzi schemes are entitled to be refunded their complete investment. In the case in question, the liquidator of the Ponzi scheme argued that under the agreements entered into between the victims and the fraudulent company, the fraudulent company would have been entitled to fees and commission. Additionally, even if the victims were not defrauded, the victims would have suffered losses due to the structure of the investment and the proposed investments. The German Federal Court held that the victims had been defrauded from the very first moment on and had no chance to receive any promised return. The victims, therefore, should not suffer any losses which would have accrued hypothetically. See File No. IX ZR 176/13. Reported by Bernd Klose, http://www.raklose.de/.

     Hundreds of investors filed a complaint against Future India and Infrastructure Industry Ltd., demanding that the firm be investigated for collecting more than Rs 5 crore from investors, promising high returns, but then failing to return their money. A complaint had previously been filed against the managing director of the company, Sreemat Kumar Mallik.

     Permission was sought to confiscate properties of alleged Ponzi scheme company, Rose Valley. There are at least 15 criminal cases against the company brought on the basis that the company defrauded investors.

     Breifne O’Brian, 52, pleaded guilty to charges that he ran a multi-million euro Ponzi scheme.

New Zealand
     Convicted Ponzi schemer David Ross, 64, is appealing his 5 year, 5 month prison sentence. Ross was found guilty of defrauding more than 700 investors out of $115 million. Ross contends that his 65-month “minimum non-parole period” is “crushing.”

South Africa
     A court ordered Dean Rees, the former attorney who helped Barry Tannenbaum run his Ponzi scheme, to pay nearly R159 to the Tannenbaum estate. The judge found “beyond any doubt” that Rees knew that he was colluding in a Ponzi scheme. Rees denied those allegations. Tannenbaum is a fugitive, but it is believed that he fled to Australia with his wife after being accused of defrauding investors out of more than $12 billion in what is known as the Frankel Scheme. The scheme lured in 880 investors, offered returns up to 216%, and represented that funds were used to buy active pharmaceutical ingredients from foreign countries which were then sold to generic makers to make antiretroviral drugs.

     Frederick Johannes Greyling aka Frik Strauss had a warrant for his arrest issued, which was then stayed as a result of a medical certificate reflecting that he was being treated for a psychiatric condition. Greyling is accused of running a Ponzi-like scheme in which he promised interest at more than 10% per month.


     Investors in the fundraising branch of the Church of God Ponzi scheme will receive a 70% distribution on their claims. The court approved the final distribution in the case that involved $85 million of investor funds.

     The Supreme Court granted a request to remove JP Morgan Chase & Co. from the list of respondents in the Bernard Madoff trustee’s case against various banks for their alleged role in the Madoff Ponzi scheme. JPMorgan has settled its claims with the trustee for $543 million.

     The Second Circuit declined to overrule the lower court’s approval of a $50.3 million settlement between an investor class and Fairfield Greenwich Ltd., a hedge fund that funneled $7 billion in the Madoff Ponzi scheme. Other defendants in the case had argued that any entity participating in the settlement could not pursue claims in any other jurisdiction. The Second Circuit did not agree and held that “Nothing in the final order precluded non-settling defendants from asserting in the District Court or in other litigation any claims or defenses that may be available to them.”

     The Supreme Court declined to review the dismissal of the Madoff trustee’s claims against banks such as HSBC Holdings Plc, that were dismissed on the grounds that the Trustee did not have standing and on the basis of the in pari delicto doctrine.

     The receiver in the Arthur Nadel Ponzi scheme won a favorable ruling from the Eleventh Circuit in connection with a fraudulent transfer claim. Wiand v. Lee, 2014 U.S. App.LEXIS 10154, (11th Cir. Jun 2, 2014). The court held that the receiver had standing to bring fraudulent transfer claims and also found that prejudgment interest could be awarded, but remanded for further proceedings.

     The College of St. Benedict in Minnesota will return $600,000 of the $2 million that it received from Tom Petter’s Ponzi scheme in connection with a settlement of a fraudulent transfer claim against it.

     A Florida appellate court upheld the lower court’s decision to deny a motion to transfer a defamation lawsuit filed by A.J. Discala against Mark A. Nordlicht and 7 other defendants. The lawsuit claims that the defendants made defamatory comments by falsely linking him to Scott Rothstein’s Ponzi scheme.

     A group of insurance companies headed by Ironshore Indemnity Inc. filed a motion for summary judgment against Banyon Income Fund LP, a hedge fund that had invested in Scott Rothstein’s Ponzi scheme. The motion seeks to void approximately $70 million of coverage granted to Banyon on the basis that Banyon allegedly made deceitful claims about the business operations in order to obtain coverage when the Rothstein scheme was disclosed. The motion alleges that Banyon had assured the insurance companies that it had only obtained pre-funded settlements and had documented settlements before advancing funds. However,“[i]n reality, the Banyon Entities knowingly advanced money before settlements were funded and without any documentation.”

     Broward Circuit Judge Nick Lopane is under investigation in connection with his handling of a divorce case involving a lawyer, Sabrina Kurzman, who worked for Scott Rothstein’s law firm, Rothstein Rosenfeldt Adler.

     Victims of the Martin Sigillito Ponzi scheme have filed lawsuits against two banks and a law firm alleging that they knew about the scheme for years and assisted in it. The Sigillito scheme defrauded 111 victims out of $56 million, promising high returns from low risk real estate investment opportunities in the British Lending Program. One lawsuit was filed against St. Louis Bank and PNC Bank, which had merged with Pioneer Bank, which had merged with National City Bank. The other lawsuit was filed against Spencer Fane Britt & Browne, alleging that a lawyer from the firm knew that the money from new investors was being used to pay earlier lenders.

     The Supreme Court declined to review the dismissal of claims brought by the receiver of the Allen Stanford businesses against Stanford employees. The lower court had held that the receiver did not have standing to bring the claims.

     The receiver of WCM777 received permission to sell properties of the company and to close frozen bank accounts. It is alleged that WCM777 was a pyramid scheme involving between $65 million to $80 million.

     The receiver and his professionals in the ZeekRewards case were awarded their fees and costs. The receiver and his firm were awarded approximately $750,000 for the first quarter of 2014.

     The ZeekRewards receiver filed lawsuits against two multi-level marketing attorneys, Howard N. Kaplan and Kevin D. Grimes, alleging malpractice, negligence, breach of fiduciary duty and aiding and abetting breach of fiduciary duty. The receiver alleged that Kaplan and Grimes “played an indispensable role in the scheme.” Among other things, it is alleged that Grimes created a “compliance course” that ZeekRewards offered for $30 and then paid $5 of that to Grimes.

Wednesday, June 18, 2014

Deepening Insolvency Comes Up for Air

Posted by Kathy Bazoian Phelps

     Deepening insolvency is alive and well, at least in the Eastern District of New York. That court recently found that deepening insolvency is an appropriate measure of damages resulting from a breach of fiduciary duty claim. Federal Nat’l Mtge. Assoc. v. Olympia Mortgage Corp., 2014 U.S. Dist. LEXIS 79479 (E.D.N.Y. June 10, 2014).

     Olympia Mortgage moved for entry of judgment on its claims for breach of fiduciary duty, among others, against Avruhum Donner, who was the former president and a principal shareholder of Olympia. The court found that, “Donner owed a fiduciary duty to Olympia, that he breached that duty, not only by causing the fraudulent transfers to be made, but also by engaging in various schemes to disguise Olympia's financial condition, and that, as a result of this breach, Olympia incurred damages in the form of increased indebtedness to Fannie Mae, among others.”

     In measuring damages on the breach of fiduciary duty claim, the court allowed the use of deepening insolvency to calculate the amount of the loss. The court reasoned as follows:
    With respect to the $43,918,500.42 claim, Olympia argues that Donner used the Check Kiting, Nominee Loan and other schemes to infuse cash into the company and to hide its liabilities, thus enabling Olympia to continue operating even though it was insolvent. Olympia further asserts that this continued appearance of solvency permitted the continued perpetration of the fraud against Fannie Mae, resulting in the increase of Olympia's liability to Fannie Mae from around $3 million in December 1997 to around $43 million in October 2004, and that Donner is liable for the entire increased amount.
    The theory on which Olympia relies, "deepening insolvency," posits that an "insolvent corporation suffers a distinct and compensable injury when it continues to operate and incur more debt." In re Global Service Group, LLC, 316 B.R. 451, 457 (Bankr. S.D.N.Y. 2004). Some courts have found deepening insolvency to provide an independent cause of action, while others have treated it as a theory of damages. See id at 457-58 (collecting cases). In this Circuit, deepening insolvency is considered "a basis for damages that may result from the commission of a separate tort." In re Allou Distributors, Inc., 395 B.R. 246, 264-65 (Bankr. E.D.N.Y. 2008). Thus, one seeking to recover under this theory "must show that the defendant prolonged the company's life in breach of a separate duty, or committed an actionable tort that contributed to the continued operation of a corporation and its increased debt." Global Service Group, 316 B.R. at 458. Here, there can be no doubt that Donner's participation in the Check Kiting and Nominee Loan schemes amounted to a breach of his fiduciary duty. And the evidence submitted provides an adequate basis upon which to infer that the perpetration of these schemes served not only to prolong the life of an already insolvent Olympia, but also to increase its debt to Fannie Mae while simultaneously depleting the assets available for repayment. I am satisfied that Olympia's $43,918,500.42 liability to Fannie Mae was caused, in no small part, by Donner's breach of his fiduciary duty, and Olympia's motion for the entry of default judgment in that amount is granted.

     For a more detailed discussion about the theory of deepening insolvency, either as an independent claim for relief or as a theory of damages, see The Depths of Deepening Insolvency: Damage Exposure for Officers, Directors and Others and The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes.

Friday, June 6, 2014

Eleventh Circuit Decides Important Ponzi Scheme Issues

Posted by Kathy Bazoian Phelps

     The Eleventh Circuit issued an opinion this week that has to make receivers happy. See Wiand v. Lee, 2014 U.S. App. LEXIS 10154 (11th Cir. Jun. 2, 2014). Fraudulent transfer claims are most often the bread and butter of a receivership estate in a Ponzi scheme case. But two hurdles often encountered by receivers in the “clawback” battles are:

1. Does the receiver have standing to bring fraudulent transfer claims?

2. Can the receiver recover prejudgment interest if successful on those claims?

The Eleventh Circuit has now addressed both questions.


     On the standing issue, there has been considerable debate as to whether a receiver is even the proper party to bring fraudulent transfer lawsuits, because the receiver’s claim must be on behalf of the receivership entity and not merely seeking redress for generalized harm to all creditors. Courts have been engaging in varied analyses to reach their decisions on this question.

     Some confusion stems from two circuit court decisions that called into question a receiver’s standing to bring fraudulent transfer claims. In Eberhard v. Marcu, 530 F.3d 122, 132-34 (2d Cir. 2008), the Second Circuit drew a distinction where the receiver is receiver over a an individual rather than a corporation, finding that when the receiver is appointed to represent the estate of an individual (rather than an entity), the receiver lacks standing to bring fraudulent transfer claims because outside of the receivership and only creditors of the individual can bring such a claim. See also Troelstrup v. Index Futures Group, Inc., 130 F.3d 1274 (7th Cir. 1997).

     Since those decisions, the Fifth Circuit found that the receiver of Stanford Financial, an entity, does not have standing to bring fraudulent transfer claims if those claims are brought on behalf of creditors. Janvey v. Alguire, 539 Fed. App’x 478 (5th Cir. Aug. 30, 2013). In a previous decision, Janvey v. Democratic Senatorial Campaign Committee, Inc., 712 F.3d 185 (5th Cir. 2013), the Fifth Circuit had considered the issue of receiver standing in facts also arising out of the Stanford Ponzi scheme. In that case, the Fifth Circuit held that “a federal equity receiver has standing to assert only the claims of the entities in receivership.” Interestingly, the Fifth Circuit issued that substitute opinion to replace Janvey v. Democratic Senatorial Campaign Comm., Inc., 699 F.3d 848, 853 (5th Cir. 2012), to “confront and correct errors of law pertaining to standing and imputed knowledge” that were contained in its original opinion.  The Stanford receiver has filed a petition for writ of certiorari to the Supreme Court asking for resolution on the question of whether a receiver has standing to assert claims on behalf of the receivership’s creditors.

     This new decision from the Eleventh Circuit in Wiand v. Lee, arising out of the Arthur Nadel Ponzi scheme, goes a long way to clear up the confusion. In citing and relying upon Judge Posner’s often cited decision in Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995), the Eleventh Circuit explained: 
A receiver of entities used to perpetrate a Ponzi scheme does not have standing to sue on behalf of the defrauded investors but does have standing to sue on behalf of the corporations that were injured by the Ponzi scheme operator. Although the corporations constitute the "robotic tools" used by the Ponzi operator, they are "nevertheless in the eyes of the law separate legal entities with rights and duties." The money they receive from investors should be used for their stated purpose of investing in securities, and thus the corporations are harmed when assets are transferred for an unauthorized purpose to the detriment of the defrauded investors, who are tort creditors of the corporations. Although the corporations participate in the fraudulent transfers, once the Ponzi schemer is removed and the receiver is appointed, the receivership entities are no more the "evil zombies" of the Ponzi operator but are "[f]reed from his spell" and become entitled to the return of the money diverted for unauthorized purposes.

Under Lehmann, the Receiver has standing to sue on behalf of the receivership entities because they were harmed by Nadel when he transferred profits to investors, such as the Lee Defendants, from the principal investments of others for the unauthorized purpose of continuing the Ponzi scheme. Although the receivership entities were the instruments of Nadel's fraud, they were distinct legal entities whose purpose was to use client funds to invest in securities, and they were harmed when Nadel diverted the funds for unauthorized uses. Applying Lehmann to FUFTA, the receivership entities became "creditors" of Nadel at the time he made the transfers of profits to Lee and others because, as FUFTA requires, they had a "claim" against Nadel. They had a "claim" against Nadel because he harmed the corporations by transferring assets rightfully belonging to the corporations and their investors in breach of his fiduciary duties, and a "claim" under FUFTA includes "any right to payment" including a contingent, legal, or equitable right to payment. Fla. Stat. § 726.102(3). See also Cook v. Pompano Shopper, Inc., 582 So. 2d 37, 40 (Fla. 4th DCA 1991) ("A tort claimant or contingent claimant is as fully protected under the Uniform Fraudulent Transfer Act as a holder of an absolute claim."). The receivership entities were thus creditors because they had a right to a return of the funds Nadel transferred for unauthorized purposes for the benefit of their innocent investors. See Lehmann, 56 F.3d at 754. The Receiver's claim thus fits within the statutory language of FUFTA, which requires the existence of a creditor and a debtor.
Wiand v. Lee, 2014 U.S. App. LEXIS 10154, at *16 - 19 (citations and footnote omitted).

     This is about as good of an explanation as receivers may ever get on the standing issue and helps reconcile the distinctions being drawn by courts on whether the debtor is an individual or an entity that has been defrauded by its principals.
Prejudgment Interest

     Wiand v. Lee also contains a good discussion on the question of whether a receiver should be awarded prejudgment interest on a fraudulent transfer claim. The receiver sought $437,734 in prejudgment interest by applying Florida’s statutory interest from the time of the transfers. The magistrate had recommended that the receiver be denied prejudgment interest “on equitable grounds,” but the Eleventh Circuit disagreed. The court noted that “Florida endorses the ‘loss theory’ of prejudgment interest according to which prejudgment interests is ‘merely another element of pecuniary damages.’” Although an award of prejudgment interest may be subject to equitable factors, the court found that the lower court had abused its discretion in not considering the governing equitable factors. Instead, the lower court had concluded that, “allowing recovery of prejudgment interest against the Lee Defendants would be inequitable because they invested in the Hedge Funds assuming their legitimacy, paying prejudgment interest would result in an award greater than the amount of their profits, and because ‘the Lee Defendants have suffered enough.’"

     So now we know that “Defendants have suffered enough” is not good enough to disallow prejudgment interest. The Eleventh Circuit remanded for further consideration on this issue.

Tuesday, June 3, 2014

Did the Second Circuit Get SLUSA Right in the Madoff Ponzi Scheme Case?

Posted by Kathy Bazoian Phelps 

     In a very short and summary opinion, the Second Circuit concluded that nothing in a recent Supreme Court decision gave it any reason to revisit its prior ruling that SLUSA bars state law class action claims against banks in connection with the Bernard Madoff scheme. In re Herald, Primeo, and Thema, 2014 U.S. App. LEXIS 9871 (2d Cir. May 28, 2014).

     As discussed previously in this blog, the Supreme Court in Chadbourne & Park LLP v. Troice, 134 S. Ct. 1058 (2014), declined to bar certain class action claims in the Stanford Financial Ponzi scheme case on the grounds that: (1) the certificates of deposits sold were not “covered securities”; and (2) the fraud was not “in connection with the purchase or sale of a covered security.”

     The Second Circuit found no application of Troice in the Madoff case. Simply put, the court said, “Because the fraud perpetrated by Madoff Securities was ‘material to a decision by one or more individuals (other than the fraudster) to buy or to sell a 'covered security,' Troice, 134 S. Ct. at 1066, the Supreme Court's ruling confirms the logic and holding of In re Herald.’”

     The Second Circuit distinguished the Stanford Financial case from Madoff, stating, “the closest that the plaintiffs in Troice could get to statutorily defined ‘covered securities’ was the allegation that Stanford induced purchase of the uncovered securities by, among other misrepresentations, vague promises that the Stanford Investment Bank had significant holdings in various covered securities.” Quoting Troice, the court noted, “Thus, a plaintiff in Troice was entirely distinguishable from ‘a victim who took, tried to take, or maintained an ownership position in the statutorily relevant securities through 'purchases' or 'sales' induced by the fraud.’"

     The Second Circuit reached the following conclusion and put an end to the class action claims against the allegedly wrongdoing banks:
Madoff Securities, by contrast, fraudulently induced attempted investments in covered securities, albeit through feeder funds (not alleged in the instant complaints as anything other than intermediaries), and the defendant banks are alleged to have furthered that scheme. Madoff Securities' victims thus "tried to take . . . an ownership position in the statutorily relevant securities," i.e., covered securities. That Madoff Securities (a Ponzi scheme) fraudulently failed to follow through on its promise to place the investments in covered securities does not in any respect remove this case from the ambit of SLUSA as defined in Troice.
     Is this type of distinction fair to defrauded victims? In Stanford, they thought they were purchasing certificates of deposits. In Madoff, they handed their money to feeder funds for investment purposes, sometimes not even knowing how their money was being invested. The straightforward and uncontested fact is that there were no sales or purchases of “covered securities” by anyone in Madoff, just like in Stanford. Is there a fair reason to say that one group can sue to recoup losses and the other cannot? The Second Circuit has interpreted Troice to make such a distinction. 

     In addition to the concern that this interpretation leads to an uneven application of the law in Ponzi scheme cases, is this result the right one in the Madoff case? First the Madoff trustee was barred from suing some of these very same banks. Now the investors are barred from seeking recovery from the banks. So who is it that gets to hold the banks accountable and obtain recoveries to reimburse the defrauded victims for their losses? At least one bank, JPMorgan, has admitted knowledge of suspicious activity while engaged in the banking activity necessary to perpetuate the scheme. The only comfort so far is that the government pursued charges against that bank and reached an agreement with the bank to pay about $2 billion. This is better than nothing, but not enough to make the victims whole.