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Recent SEC Releases

California Man Gets 14-Year Prison Sentence For $2.7 Million Ponzi Scheme

A federal judge sentenced a California man to a fourteen-year prison term for operating a real estate Ponzi scheme that duped family and friends of nearly $3 million.  James Berghuis, 42, received the sentence from U.S. District Judge William B. Shubb, who factored in Berghuis' lack of "conscience" in fashioning his sentence. Berghuis chose to stand trial on the charges last year, which resulted in a federal jury convicting him on four counts of mail fraud, four counts of wire fraud and one count of laundering money.  Berghuis could have potentially faced decades in prison.

From 2005 to 2007, Berghuis used his company, Berghuis National Lending Inc. ("BNLI") to solicit potential investors to take out home equity loans in order to invest in hard-money loans, real estate parcels, or the purchase of real estate franchises.  Investors were assured that the investment was safe, and some were offered a deed of trust purportedly giving them a second position on the asset underlying their particular investment.  In total, Berghuis raised millions of dollars from family members, friends, and acquaintances.

However, Berghuis did not use investor funds as promised; instead, he diverted funds for his own personal use and paid out fictitious returns to existing investors.  In one situation, Berghuis signed over a $200,000 check he had received from a new investor to a car dealership to take possession of a top-of-the-line Mercedes sports car.  Meanwhile, when funds began to run out, investors received various excuses as to why Berghuis could not make the promised payments; many investors ultimately lost their houses or were saddled with significant mortgages as a result of Berghuis' encouragement to use home equity money for the investment.



Madoff Recoveries Top $10 Billion After $497 Million Settlement

The court-appointed trustee tasked with recovering assets for victims of Bernard Madoff's massive Ponzi scheme announced a $497 million settlement with two Cayman Islands hedge funds that brings the total amount recovered to approximately $10.3 billion.  Irving Picard, the bankruptcy trustee for Madoff's now-defunct broker-dealer, filed a Motion to Approve Settlement (the "Motion") with Herald Fund SPC and Primeo Fund (the "Funds"), two "feeder" funds that had funnelled investor funds to Madoff.  With the settlement, Picard has now recovered approximately 59% of the estimated $17.5 billion in losses attributable to Madoff's fraud; with the inclusion of funds paid to victims from Madoff's membership in the Securities Investor Protection Corporation, all investors with losses of $925,000 or less have been fully paid back.

The Funds maintained various accounts with Madoff's firm, investing both directly and through other funds that also had exposure to Madoff.  In the six years preceding the collapse of Madoff's scheme, the Funds withdrew more than $700 million in invested principal from Madoff's firm.  Picard filed lawsuits against Herald and Primeo in July 2009, and subsequently filed an amended complaint on December 5, 2010.  As a protective measure, Picard also filed a proceeding against Primeo in the Cayman Islands.

Under New York law, transfers within six years of the filing of a bankruptcy petition may be recovered as proceeds of a fraudulent transfer.  Because Madoff admitted to running a Ponzi scheme, these transfers are considered to be made with the actual intent to hinder, delay, or defraud.

While settlement negotiations had been ongoing for several years, the Motion implied that a Cayman court's 2013 placement of Herald into official liquidation - which replaced the fund's board of directors with a court-ordered slate - may have been the turning point.  Picard entered into mediation with the Funds earlier this year, and recently reached an agreement.

The agreement calls for Herald to pay approximately $467 million to Picard, which includes a $100 million credit relating to an investment in Herald by JP Morgan that Herald had long maintained should be factored into any amount it purportedly owed.  In addition, Primeo would pay approximately $29 million, which brings the total settlement by the funds to approximately $497 million.

The settlement also includes the allowance of a customer claim filed by Herald of approximately $1.64 billion, which Picard indicated represents Herald's net equity of $1.172 billion and the $467 million paid into the estate as part of the settlement.  Notably, this claim amount would likely place Herald as among one of the largest investors in Madoff's scheme.  As part of the settlement, Picard will make a "catch-up" distribution to Herald, since it was not allowed to receive distributions made to victims over the past few years due to the pending litigation, representing 46.059% of its allowed losses of $755,320,133 - of which Herald will use a portion to contribute its settlement amount with Picard.

Interestingly, while Herald filed a claim with Madoff's bankruptcy estate claiming scheme-related losses, Primeo did not.  While the Motion for Approval of Settlement does not disclose the amount of Primeo's losses, it does disclose that all transfers made by Primeo during the six-year period preceding the bankruptcy filing were withdrawals of principal.  Thus, it is entirely possible that Primeo's failure to file a proof of claim may have prevented it from recovering a significant portion of its losses, as Herald was able to do.

A hearing is scheduled for December 17, 2014 to present the settlement for court approval.

A copy of the Motion is below:

Madoff Settlement


Florida Men Plead Guilty To $19 Million Ponzi Scheme

Two Florida men have entered guilty pleas to charges that they operated a Ponzi scheme that raised nearly $19 million by peddling "guaranteed" certificates of deposit to mostly elderly investors.  Donald Ray Babb, 58, of Merritt Island, Florida, and Ralph Ruth, of Melbourne, Florida, each pleaded guilty to a single charge of conspiracy to commit wire fraud.  Each man faces up to twenty years in federal prison at a sentencing likely to take place in early 2015.

Babb and Ruth operated several businesses, including Southeast Mutual Insurance and Investment LLC, Capstar Industries LLC, and First Merchant Capital LLC (the "Companies").  The men met while working in the automobile dealership industry, and beginning in 2006, began soliciting potential investors through word of mouth and newspaper advertisements on claims that the Companies were licensed financial institutions offering risk-free certificates of deposit with high rates of return.  The Companies would ultimately raise nearly $19 million from at least 150 investors, many of whom were elderly and who invested a significant portion (or all) of their life savings.

However, there were no certificates of deposit offering high rates of return; instead, Babb and Ruth used the Companies to orchestrate a classic Ponzi scheme whereby funds from new investors were used to pay interest and principal redemptions to existing investors.  The men used investor funds to live a life of luxury that included the purchase of high-end watercraft, three airplanes, and real estate in Florida and North Carolina.  The scheme collapsed in late 2013, and the pair were later arrested.  An investigation found that, of the approximately $18.5 million raised by the Companies, approximately $7.8 million was repaid to investors in the form of interest payments and return of principal.

In addition to criminal charges, the Florida Office of Financial Regulation brought civil fraud charges against the men and the Companies.  A court-appointed receiver has recovered approximately $1 million


Former Tennis Team Owner Gets 20 Years For $150 Million Latex Glove Ponzi Scheme

A California man who once owned a professional tennis team has been sentenced to a twenty-year prison term for orchestrating a massive Ponzi scheme that duped victims out of over $100 million.  Deepal Wannakuwatte, 63, received the sentence from U.S. District Judge Troy Nunley who, after hearing testimony from various victims defrauded by the scheme, branded Wannakuwatte a "liar" and "evil person" and delivered the maximum sentence under the law.  Wannakuwatte had previously agreed to plead guilty to a single count of wire fraud after facing charges that could have resulted in up to a 90-year sentence. 

Wannakuwatte operated International Manufacturing Group ("IMG") and RelyAid Global Healthcare Inc. ("RelyAid") (collectively, the "Companies"), telling potential investors that the Companies had lucrative contracts providing surgical gloves to various government agencies.  Investors were told that the Companies had annual sales exceeding $100 million, including more than $125 million in contracts from the U.S. Department of Veteran Affairs ("VA") alone.  Based on these representations, Wannakuwatte and the Companies took in more than $200 million from at least 100 victims.  

However, authorities allege that Wannakuwatte grossly overstated the extent of the Companies' dealings with the VA - indeed, rather than $100 million in sales from the supply of medical gloves, authorities claim that the actual amount of the contracts were $25,000, and the Companies; total 2013 sales were just $5 million.   The scheme began unraveling late last year when Wannakuwatte, his wife, and the Companies were sued by a creditor, General Electric Capital Corp. ("GE Capital"), who claimed that RelyAid had defaulted on a loan it had taken out to purportedly build a latex glove factory.  Wannakuwatte was ordered to turn over a $3 million King Air private plane that had been pledged as collateral on the loan, and multiple government agencies began investigating Wannakuwatte and the Companies shortly thereafter.

After being arrested in February on mail fraud, wire fraud, and bank fraud charges, Wannakuwatte pleaded guilty several months later to a single count of wire fraud.  As part of that plea agreement, prosecutors agreed to seek a 20-year sentence - the maximum allowed under a wire fraud charge.  After accounting for distributions received by victims, total losses were estimated at approximately $109 million.

However, Wannakuwatte's previous sentencing in August 2014 was delayed when, at the sentencing hearing, Wannakuwatte's lawyer presented Judge Nunley with a note claiming that his current lawyer, Donald Heller, had been "intimidating" towards him and that he had retained another attorney.  Heller, a well-regarded criminal defense attorney and former federal prosecutor, later denied the accusations to a reporter and stated that it was in Wannakuwatte's best interests to plead guilty given the "overwhelming" case against him.  Wannakuwatte's new counsel, Philip Cozens, appears to have convinced his client that he was facing a significant uphill battle in trying to revoke his plea agreement.

A hearing is scheduled in January 2015 to determine the exact amount of losses, as the figures advanced by the government and Wannakuwatte's defense differ by tens of millions of dollars.


Judge Denies Charging Lien On Ponzi Victim Distributions 

A federal judge has issued an order denying an attempt by lawyers for certain victims of the $600 million ZeekRewards Ponzi scheme to place a "charging lien" against hundreds of thousands of dollars in interim distributions due to those victims.  U.S. District Judge Graham C. Mullen issued the order nearly two months after Marc Michaud, a New Orleans lawyer with the firm of Patrick Miller LLC, filed a Notice of Attorney's Charging Liens asserting "attorney’s charging liens and other privileges for legal services performed and costs incurred by Attorney in connection with the representation of" approximately 400 claimants.  In the order, Michaud was also ordered to "immediately and without further delay" provide the contact information for his clients to allow the Receiver to make the first interim distribution directly to those clients.  

Michaud filed the Notice of Attorney's Charging Liens in late September, seeking to create a security interest entitling Michaud and his firm to a portion of distributions made by court-appointed Receiver Kenneth Bell to Michaud's clients.  The exhibit attached to the original Notice listed approximately 400 claimants holding over $1.34 million in total claims who supposedly signed a contingency fee contract with Michaud's law firm agreeing to turn over a portion of any funds recovered from the scheme.  However, it appears that the only assistance provided by Michaud's firm was the filling out of proof of claim forms for those victims as part of the court-approved claims process; indeed, each of the proof of claim forms filled out for those victims listed Michaud's law firm as the address to which distributions should be sent.

Kenneth D. Bell, the court-appointed receiver, opposed sending victim distributions to any third party, and filed a motion in December 2013 seeking court approval for distribution procedures that included a provision that payments would be made directly to victims.  Michaud's firm filed a pointed objection, claiming that the payments should be sent directly to their firm and characterizing the Receiver's decision as a refusal to consider their clients' claims and a violation of the victims' constitutional due process rights.  In his response, the Receiver dismissed the Law Firm's claims, noting that the fee agreement had been procured as part of a class action that had been filed in violation of the stay order, and taking issue with the attorneys' right to such a "large" fee simply for filling out an online claims form.  The Receiver also noted that

whether or not the fee agreement would permit Movants’ counsel to claim a large contingent fee (as much as 25%) for simply providing administrative assistance in filing a claim through the Receiver’s claim portal is uncertain.

Judge Mullen subsequently approved the Receiver's Motion in all aspects.

Following the filing of the Notice of Attorney's Charging Liens, the Receiver filed a sharply-worded objection contending that the Notice "appears to be an attempt by Mr. Michaud to circumvent the Court’s prior orders regarding this issue and insert himself as the recipient of money that belongs to victims."  The Receiver also noted that nearly all of Michaud's clients were included in the group of victims that had not yet received the first interim distribution made in late September 2014 due to the fact that Michaud's firm had failed to follow an earlier court order requiring the amendment of certain claimants' mailing information to reflect their actual address rather than that of the Law Firm.  The Receiver also insinuated that, in failing to comply with the order, the Law Firm may also have violated rules governing attorney conduct in both Louisiana and North Carolina by placing the financial interest of the Law Firm over that of their clients.  

The Receiver raised multiple issues with the entitlement to a charging lien for representation of Ponzi scheme victims, and concluded that 

Here, a charging lien is inappropriate given that Mr. Michaud continues to represent these victims in a matter which has not yet been resolved; there is no evidence of either an avoidance of payment or a dispute as to the amount of fees; and there is no indication that these victims have received notice that Mr. Michaud seeks to claim 25% of this first distribution. 

Under the terms of Judge Mullen's Order, Michaud's firm is directed to "immediately and without further delay" provide the direct contact information for his clients to the Receiver so that those victims may receive the first interim distribution.  While Michaud had apparently sought the use of a charging lien to prevent the scenario where he was forced to collect the contingency fee directly from his clients, it appears that he will have no other choice with the Court's ruling.  

A copy of Judge Mullen's Order is below (as always, thanks to ASD Updates)

Zeek Doc 283