RECEIVERS: WHY IS EVERYONE UNHAPPY?

1
RECEIVERS WHY IS EVERYONE UNHAPPY?

• Wayne Klein
• Lewis B. Freeman Partners, Inc.
• August 15, 2009

2
Anatomy of a Ponzi

• From 1997 to 2002, J.T. Wallenbrock raised 253
  million from investors.
• Investor funds purchased accounts receivable from
  a Malaysian latex glove manufacturer.
• Promissory notes said 15 profit in 90 days.
• Investors were told there was no risk
• 85 of contracted sales price was paid to the
  manufacturer only when gloves were shipped,
• purchasers paid the investors full price for the
  gloves immediately upon arrival in the U.S.

3
What was the problem?

• There were no latex gloves!!!
• The SEC sued and a Receiver was appointed.
• The Receiver found
• 113.8 million was paid to investors as returns.
• 11.1 million for office expenses and payroll.
• 25.5 million in personal and business expenses,
  including 3 MM in cash, credit card payments.
• 99.8 million funded 175 start-up companies.
• 3 million in bank at the time of the asset
  freeze.

4
Disgorgement ordered

• Defendants consented to an injunction and agreed
  to pay disgorgement.
• Court ordered repayment of full 253 MM.
• Defendants appealed, arguing
• No duty to disgorge 36 MM in operating costs.
• No duty to repay money loaned to venture capital
  investments.
• Should not have to pay over to investors monies
  earned from outside business ventures.

5
Appeals court was unconvinced

• All 253 million was unjust enrichment and must
  be repaid.
• Defendants do not get an offset for entirely
  illegitimate expenses incurred to perpetrate an
  entirely fraudulent operation.
• Unjust to permit the defendants to offset . .
  . the expenses of running the very business they
  created to defraud those investors . . . .
• A defendant could not offset 1.2 million he lost
  against disgorgement he owed.

6
Hypothetical 1

• Investor put 500,000 into Ponzi scheme six years
  before its collapse.
• Investor was paid 100,000 distributions
  annually.
• Most recent account statement from Ponzi operator
  shows 500,000 principal balance.
• After this scheme collapses, how much can the
  investor claim from the Receiver?
• Who will be happy? Who will be unhappy?

7
Hypothetical 2

• Stu, a personal friend, loans 68,000 to Ponzi
  operator as scheme is collapsing.
• After SEC sues and court freezes assets,
  fraudster contacts HH, a company that owes him
  money.
• To satisfy the debt, HH transfers real property
  to Stu.
• Ponzi operator has Stu borrow 63,000 from a
  hard-money lender, using property as collateral.
• Receiver discovers property transfer.
• What should Receiver do?
• Who will be happy? Who will be unhappy?

8
Hypothetical 3

• Receiver analyzes bank records and finds 5,000
  paid by fraudster to Mortimer.
• Receiver asks why. Mortimer responds
• He is high school teacher who sells his blood to
  supplement his income.
• His LDS bishop visits him, saying he was
  embarrassed at how he supplements income, gives
  him 5,000 check from Ponzi company.
• Should Receiver demand a return of funds?
• Who will be happy? Who will be unhappy?

9
Hypothetical 4

• Receiver takes inventory of assets, finds lake
  house under construction in resort area.
• Each of two adjacent lots cost 800,000.
• 1.6 million has been spent on construction to
  date home is 70 completed.
• Potential buyer offers 1.4 million for home and
  both lots.
• What factors should the Receiver consider?
• Should the Receiver take the offer?
• Who will be happy? Who will be unhappy?

10
Why does the SEC seek Receivers?

• Theory it frees up SEC to bring other cases.
• Reality the theory is true, but, it also results
  in someone else playing the bad guy.
• Receiverships take enormous time and specialized
  expertise.
• Asset freezes give a great advantage to the
  government defendants cannot use entity funds to
  pay their attorneys.
• There are risks to the government too . . . .

11
Who controls the Receiver?

• Once appointed, the Receiver is answerable only
  to the court.
• Receivers are granted enormous discretion.
• Stanford case exposes potential conflicts
• Innocent investors hold proceeds from CD
  purchases in domestic brokerage accounts.
• Court order freezes investor access to accounts.
• Receiver sues investors, seeking these funds.
• SEC files emergency motion to reclaim exclusive
  authority to pursue claims against investors.

12
Types of claims made by Receivers

• Assets of Ponzi operator and family.
• Balances in bank, brokerage accounts.
• Charitable contributions.
• Investments, joint ventures.
• Payments made for debts of others.
• Payments made for benefits of others.
• Unconsummated transactions.
• Overpaid investors.

13
Other targets of Receivers

• Receivers bring claims against others who
  assisted or just ignored the fraud.
• These include gatekeepers such as
• Law firms
• Banks
• Accounting/auditing firms
• Officers and directors
• Receivers may fight among themselves
• Liquidators from Antigua were awarded control of
  196 million in Stanford assets in the U.K.

14
The Receivers arsenal

• Receiver is often exempt from unclean hands
  defense.
• Fraudulent conveyance laws
• Can recover funds paid by an insolvent entity.
• Actual fraud vs. constructive fraud.
• If actual fraud, all payments must be returned.
• If constructive fraud, only net profits come
  back.
• Badges of fraud can help prove fraud
• Diverted funds, false statements, no profits.

15
Good faith defense

• Good faith defense is an affirmative defense.
• It is a high standard the investor had no
  knowledge of problems or suspicions about
  viability of the enterprise.
• Good faith only protects principal.
• Any net payments go back to the receiver for
  distribution to investors pro rata.
• For an excellent discussion of these issues, see
  Donnell v. Kowell, 533 F.3d 762 (9th Cir. 2008).

16
Who can Receivers trust?

• Madoffs wife was accountant for Madoff, but
  claims she was innocent and had separate wealth
  for Manhattan apartment.
• Some Ponzi operators claim they have assets
  overseas and offer to go get them.
• Spouse could not explain why she signed note and
  personal guarantee for 40 loan.
• Investors provide evidence of investments made,
  but understate size of withdrawals.

17
Learning the truth

• Ponzi operators lie.
• Fraudster had inadequate or no records.
• False records
• Fictitious account statements
• Palmer financial statements on computer
• Tax returns on computer showed 1 million payment
  of estimated taxes.
• Possible solution limited immunity by prosecutor
  for assistance to Receiver?

18
Complaints about Receivers

• Size of fees.
• They seek clawbacks from investors.
• Refuse to permit investor withdrawals.
• Not honoring balances on account statements.
• No recovery for indirect investors.
• Should not target attorneys, banks, or CPAs.
• Cooperation with the Receiver will result in the
  SEC learning information.
• No ongoing living allowance.

19
More complaints

• Deny funds for criminal, civil defense.
• Receiver is perpetuating improper actions by the
  SEC in stopping a legitimate business enterprise
  and destroying its value.
• Should not sell assets before case has been
  proven against the Ponzi operator.
• Conflicts of interest.
• Receiver is too aggressive.
• Receiver is not sufficiently aggressive.

20
Targets of investor anger

• A New York Times reporter offered up this defense
  of the Madoff receiver
• But the essential unfairness is Mr. Madoffs
  fault, not Mr. Picards. He has been left with a
  series of unpalatable choices . . . .
• Every time he decides not to claw back money
  from that cancer patient who cannot afford
  treatment, he is depriving some other Madoff
  investor of money that belongs to him.
• No matter what he does, someone gets hurt.

21

• LBF is a forensic accounting and litigation
  consulting firm that
• Has principals that act as receivers and
  trustees,
• Performs forensic accounting,
• Conducts due diligence, internal investigations,
• Provides professional advising on internal
  controls, SOX compliance,
• Manages restructurings and business workouts,
• Provides specialized subject-matter expertise in
  securities, commodities, banking, hotel, and real
  estate, and
• Serves as expert witness.

• Contact Information
• Wayne Klein
• Lewis B. Freeman Partners, Inc.
• _____
• 3225 Aviation Avenue, Suite 501
• Miami, FL 33133
• [phone]
• www.lbfglobal.com
• _____
• 299 South Main, Suite 1300
• Salt Lake City, UT 84111
• [phone]
• [phone] (cell)
• wklein_at_lbfglobal.com