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How the Securities and Exchange Commission Battles the Progeny of Charles Ponzi-Using Receivers as an Important Tool By Phelps, Kathy Bazoian* Securities and Exchange Commission receiverships in Ponzi cases was the focus of the California Receivers Forum’s LA/OC Chapter – sponsored educational program on October 27, 2010 in downtown Los Angeles. More than seventy attorneys and other professionals attended the sold-out luncheon program, hosted by the Buchalter Nemer firm. Panelists included John M. McCoy III, Regional Trial Counsel in the SEC’s Los Angeles Office, and three professionals with significant expertise in SEC receiverships – receiver Steve Donell, counsel Kathy Bazoian Phelps of Danning Gill Diamond & Kollitz, LLP, and accounting professional Howard Grobstein, partner-in-charge of the Crowe Horwath firm’s Los Angeles office. The program began with an outline of a typical Ponzi scheme and its cast of characters, including: the management team and insiders who ran the scheme and looted the illegally-generated assets; the lawyers, accountants, and auditors who supported the scheme; the brokers who sold the Ponzi investments to unwitting buyers; and the defrauded investors – some who may have been paid substantial returns from the Ponzi scheme’s fictitious profits. John McCoy discussed why the SEC seeks appointment of a receiver and the red flags that attract the SEC’s attention to such fraudulent schemes. He went through the process and practicalities of obtaining a receiver’s appointment, and offered insight into the SEC’s decision-making process regarding appointment of receivers and importance of the receiver’s independence. Mr. McCoy stressed the critical importance of the receiver’s cooperation in preserving evidence related to the criminal investigation. Steve Donell, who has served as receiver in several SEC cases, discussed what he characterized as the “controlled chaos” experienced in the early weeks after a receiver is appointed in a Ponzi scheme case. He offered practical tips on how to secure property, records and electronic data, and discussed how to effectively implement a strategy to ensure a successful securities fraud case. The importance of surprise and speed in taking over the suspected perpetrator’s property, as well as the coordination needed among the receiver’s agents and professionals to lock down bank accounts, assets and records were among topics discussed. He also addressed the intersection of the civil SEC case and the criminal prosecution that typically already has been or will be filed – requiring document preservation, computer imaging and detailed documentation of the source and location of files and data for future use by the criminal authorities. Last, Mr. Donell commented on the importance of maintaining investor relations, including the importance of immediately launching a case information website and of responding to the hundreds of calls and inquiries from distraught investors. Kathy Phelps, with wide experience in representing receivers in SEC cases, discussed the variety of litigation cases a receiver can pursue when the tangible assets are gone or are insufficient to compensate the defrauded victims and other creditors. Claims for breach of fiduciary duty, fraud, negligence and avoidance of fraudulent transfers based on either actual intent to hinder delay and defraud creditors or constructive fraud, were among those discussed. Fraudulent transfer actions can be used to recover: (1) payments made to investors as a return of their principal or payment of fictitious profits; (2) commissions paid to sales people and brokers; (3) gifts made to family and friends; and (4) charitable contributions made by the Ponzi scheme debtor, she said. Ms Phelps also discussed the issues raised by the legal defenses to these claims, including the confusion over the meaning of “good faith” for investors and brokers when they try to hold on to the money they have been paid. She also examined the applicability of the in pari delicto doctrine as a result of the wrongful conduct of the entity in receivership’s insiders [see Ms Phelps’ extended article on this topic beginning on Page One of this issue of RN – Ed.]. Howard Grobstein, an experienced forensic accountant skilled in providing accounting support for SEC receivers, discussed the process of keeping an inventory of records, how to trace funds and make findings for the receiver, and the tax issues that arise in Ponzi cases. The first key issue for the forensic accountant to handle involves securing both electronic and hard copy data – data to be used to determine whether fraudulent conduct occurred, to analyze transactions and to prepare tax returns for the receivership estate, he explained. There are specific methodologies used to trace funds and determine whether the receiver has claims against various parties including insiders, investors and professionals that may have been involved in the scheme, Mr. Grobstein said. He ended his discussion with an explanation of the importance and complexity of tax issues in receiverships. *Kathy Bazoian Phelps, Esq. is a partner in the Los Angeles office of Diamond McCarthy LLP. She has special expertise in all areas of bankruptcy and receivership law and in representing trustees and receivers in large-scale litigation involving fraudulent and Ponzi schemes. She is a Board Member of the Los Angeles/Orange County Chapter of the California Receivers Forum. |