Spring 2017 • Issue 60, page 14

Twists, Turns and Tactics: Successful Ponzi Scheme Litigation in Receivership

By Mirman, Alan*

Most receivership cases don’t consume seven years or involve international searches uncovering overseas assets, and locating a fraudster in a sushi bar in Vancouver. Each case follows its own unique path, but perhaps none with more strategy issues, critical timing, and intrigue, than the unwinding of a Ponzi scheme. I had the pleasure of representing Stephen J. Donell in such a case, which recently wrapped up after 7½ years. It took that long for the Receiver to locate, collect, administer and distribute the ill-gotten gains of an entity we’ll call XYZ Enterprises. This article recaps some of the many twists, turns and tactics which led to a successful outcome, a delighted judge, and appreciative investors. Let me tell you the story…

Filing of the Action by Plaintiff and Appointment of Receiver.

Plaintiff Investor filed the lawsuit in 2009 seeking damages for breach of a document entitled “Security Agreement” by XYZ and its principal, the fraudster, whom we’ll call Mr. B, alleging that XYZ had breached its promise of monthly interest payments of at least 18% per annum on invested funds. Plaintiff moved for the appointment of a receiver, and Defendants stipulated, likely because Mr. B saw cooperation as his figurative but effective “get out of jail” card. While the Order Appointing Receiver vested in the Receiver control over all the assets of XYZ, it was the later expansion of those powers during the course of the receivership that played a pivotal role in maximizing collections.

Investigation by Receiver, Retention of Professionals and Expansion of Receivership.

The Receiver took control of the office and assets of XYZ but most business records of the activities of XYZ had been destroyed. The Receiver pieced together information from the minimally available investor records and bank account information. Due to the poor records, the Court granted the Receiver further powers, including obtaining control of Mr. B’s laptop and hiring a forensic computer consultant to examine that laptop. The Receiver also hired a forensic accounting firm to recreate books and records for XYZ based on subpoenaed account information. The Receiver could then determine who were “winners” and “losers” and identify secreting of funds.

After a legal battle over attorney/client privilege and privacy issues with Mr. B, the Receiver’s computer consultant reviewed records hidden in databases maintained on Mr. B’s personal laptop computer, which proved useful in the search for hidden assets.

From inception, the Receiver set up a comprehensive and very user-friendly website to allow investors to access information, including filings and Status Reports, about the status of the case. The Receiver and counsel kept the process as transparent as possible to keep the Court and investors advised of the status. During the seven year case, I filed seventeen Interim Reports and Fee Applications. The multiple benefits are obvious – first, the Court, counsel and visitors to the Receiver’s website stayed apprised of all developments. Second, and not to be minimized, the fees incurred by Receiver, counsel and experts were approved on a regular basis (usually at four month intervals) so that everyone got paid, and we avoided any later second-guessing as to fees or the work done.

Determination of Ponzi scheme conducted by XYZ.

The Receiver’s investigation concluded that the purported “factoring” business conducted by XYZ was a cover for an elaborate Ponzi scheme – an enterprise with no real business. Early investors were paid only with funds received from later investors – the classic Ponzi scheme. Eventually the pyramid collapsed, when there were insufficient new funds to pay the ever-growing requirements to pay out existing “investors.”

Mr. B’s Ultimate Flight to Canada.

The Receiver cooperated with Federal law enforcement agencies, who were pursuing a criminal case against Mr. B. This was not any secret – the Receiver reported on his own cooperation in this regard in his periodic Interim Reports. Mr. B, initially motivated to cooperate to obtain more favorable treatment by the prosecuting authorities, turned over a significant amount of funds and other assets. Mr. B’s cooperation, however, lasted only so long, and the Receiver ultimately had to file a motion seeking to have Mr. B held in contempt of court, which was granted. Mr. B was ordered to provide cooperation or face imprisonment. He chose not to, and to the surprise of all involved, he abandoned his wife and home, and fled to his native Canada. Using a private investigator, the Receiver found Mr. B hiding in Vancouver, resulting in the recovery of real and personal property assets that Mr. B hid, acquired and/or took with him into Canada.

When Mr. B was eventually arrested, the Vancouver Police seized significant assets, including a suitcase full of a substantial amount of cash and three computer flash drives. At the bail hearing, the Canadian judge ordered the seized funds to be turned over to the Court, with $50,000 of the seized funds held as a bail deposit. Mr. B was confined to his then current place of residence and was required to surrender both his Canadian and United States passports.

Mr. B challenged the seizure and turnover of assets and the flash drives in the Canadian court, as well as the U.S. authorities’ attempts to extradite him to the U.S., but was unsuccessful, and the assets were turned over to the Receiver. Mr. B filed various appeals of Canadian Court Orders against him on the extradition issue up to the time of his death, in January 2015. At that point, the money posted for Mr. B’s bail was turned over to the Receiver.

Asset Recovery for the Receivership Estate.

Through the seizure of bank accounts, liquidation of physical assets, and recovery of monies improperly paid out by XYZ, the Receiver’s efforts resulted in the capture of approximately $19 million for the Receivership Estate.

  1. Expansion of the Receivership Estate to Include Mr. B and his wife.

    One of the first steps instrumental in the capture of significant additional assets was the expansion of the Receivership to include Mr. B and his wife and their personal assets. This allowed the Receiver to reach investor funds improperly used by Mr. B and his wife, including real property and accounts in Canada, and bond accounts held in Israel. Mr. B cooperated initially in this regard, likely hoping to diminish exposure for extended prison time and to obtain a stipend for his spouse. With Court approval, the Receiver employed Canadian counsel to obtain a “Recognition Order” establishing an ancillary receivership in Canada.
     

  2. Recovery of Monies Paid to Mr. B’s Criminal Defense Counsel.

    By tracing the source of a seven figure retainer paid by Mr. B to criminal defense counsel, the Receiver established that monies obtained directly through the Ponzi scheme had been used to pay that retainer and were subject to disgorgement by the counsel because they came directly from investor dollars. After negotiations, the Receiver recovered most of those funds, and importantly, criminal defense counsel waived any and all claims as a creditor in the Receivership Estate, thus freeing up those funds for payment to investors.
     

  3. Liquidation of Real Estate.

    Various parcels of real property that were ultimately sold by the Receiver. Two of the properties were condominium units, which led to monthly expenses pending sale to the detriment of the receiver’s bottom line. Eventually, the Receiver was required to take action in order to obtain possession of one of the units from Mr. B’s spouse, who did not vacate as promised.

    Through his investigation after Mr. B fled to Canada, the Receiver also found and took possession of a luxury condominium owned by Mr. B in Canada. Mr. B was in escrow to sell the condominium at the time the Receiver located it, but the Receiver’s Canadian counsel intervened the very week escrow was to close, and obtained the proceeds for the Receivership Estate.
     

  4. Fraudulent Transfer (“Winner”) Cases against XYZ Investors.

    A very significant part of the Receivership activities related to litigation brought by the Receiver against those individuals identified as “winners” of XYZ. In very general terms, “winners” are those individuals who received greater returns from XYZ than the amounts they “invested.” The Receiver sought recovery of these excess amounts through “clawback” lawsuits.

    The Order was again expanded to authorize the Receiver to commence litigation to recover the fraudulent transfers if necessary. The Receiver sent out demand letters and negotiated settlements with many of these “winners.” As to those “winners” with whom a settlement could not be reached in a timely manner, the Receiver initiated clawback lawsuits. There were a total of 58 lawsuits filed by the Receiver against winners, all of which were either settled or resulted in default judgments entered against named defendants. The settlements and judgment recoveries created a significant net benefit for the Estate.

Claims Procedure

We knew after the reconstruction of records that (a) there would be a dispute as to claims made by investors and others; and (b) that there would very likely not be sufficient funds to pay all claims. After obtaining early Court approval for a “claims procedure” to determine valid claims from those damaged by XYZ, the Receiver sent out claims packages to investors and other known creditors. The packages included a cover letter from the Receiver, a Notice of Bar Date, a Receiver’s Distribution Plan, and Claim Form. The Receiver also advertised in newspapers of general circulation, and posted the claim information, instructions and forms on his website.

The Receiver evaluated and processed the approximately 270 claims submitted which totaled more than $44 million. The Receiver filed a Motion for Order Approving Receiver’s Proposed Acceptance, Rejection and Responses to Claims, and Authorizing Interim Distribution of Receivership Funds to Approved Claimants. The Claims Motion described how the Receiver had processed the numerous claims, and reached agreement (or a lack of objection) as to his treatment of all except for fourteen of the approximately 270 claims. After a lengthy hearing, the Court entered its Order on the Claims Motion, approving claims totaling approximately $27 million.

Final Distribution

Early in the case, the Receiver made several interim distributions of Receivership Estate funds to investors with claims approved by the Court. Upon approval of the Motion to Approve Final Account, the Receiver made a final distribution, bringing the total distribution to almost $16 million. The total amount distributed was almost 60% of the approved claims. Once all known assets were collected and distributed, it was time to wrap up the case.

Conclusion

What is to be learned from this saga? First, is that it is immensely satisfying to seek recoveries on behalf of defrauded investors. Second, is that tactical maneuvers and speed of execution are paramount in seeking to achieve a beneficial result, while organization of facts and documents may be almost as important. Third, is the not-surprising moral of the story – constant communication with the Court, counsel and interested parties will create allies and supporters, rather than alienated victims. Should you be fortunate enough to become enmeshed in a multi-faceted and challenging situation such as this, I wish you the best.

*Alan M. Mirman is a partner in the Woodland Hills law firm of Mirman, Bubman & Nahmias, LLP, and specializes in creditor’s rights. His practice includes provisional remedies, representation of receivers, litigation, loan and lease documentation, and the like.