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Recent SEC Releases

Lawyers Seek Approval To Distribute Clawback Recoveries To Ponzi Victims

Victims of one of the largest Ponzi schemes uncovered in Ohio could soon receive a partial return of their losses based on efforts by attorneys to "claw back" fictitious profits paid to some investors.  Attorneys representing victims of Glen Galemmo's $35 million Ponzi scheme are set to appear in a Cincinnati federal court next week to seek approval to distribute over $3 million recovered in "clawback" lawsuits brought on behalf of defrauded Galemmo victims.  While the federal government has collected an additional $5 million through asset forfeiture, distribution of those assets to victims may not take place until 2016 while an appeal filed by Galemmo's wife is heard.

The Scheme

Galemmo operated Queen City Investment Fund ("Queen City"), along with a dozen other investment entities. Touting himself as an experienced trader, Galemmo promised outsized returns through investments in stocks, bonds, futures, and commodities.  Investors were told Queen City had enjoyed a streak of consistently above-average returns, including a return of nearly 20% in 2008 when the S&P 500 experienced a -38.49% loss. Galemmo assured investors that Queen City was audited annually, and provided monthly statements showing steady returns.  Galemmo raised more than $100 million from individuals, trusts, and even charities.

However, Galemmo's touted trading prowess was pure fiction.  Instead, Galemmo used new investor funds to pay his promised returns - a classic hallmark of a Ponzi scheme.  Nor was the Queen Fund audited; rather, Galemmo simply listed the name of an audit firm that had not had a relationship with Galemmo or his fund since 2003.  Investors received fictitious account statements, and Galemmo paid himself tens of millions of dollars in fictitious management fees, which he used to purchase real estate, pay fictional interest and principal distributions, and even to operate other businesses such as entertainment complexes. 

The scheme collapsed in July 2013 when investors received an email from Galemmo stating that the funds were shutting down and directing all further inquiries to an IRS agent.  Victims filed a lawsuit later that month, and Galemmo was later arrested.  He agreed to plead guilty shortly thereafter, and recently received a 15-year sentence.  

The prospect of recovery for victims appeared bleak, with one source reporting that the Department of Justice estimated that victims could recoup 10% to 20% of their investment.  Authorities were able to quickly seize what remained of Galemmo's assets, which included over $500,000 in cash, various real estate including a condo in Florida and Galemmo's former office building, and over $100,000 in automobiles.

Investors Take Matters Into Their Own Hands

Last year, the Commodity Futures Trading Commission ("CFTC") filed a civil enforcement action against Galemmo and Queen City.  The CFTC did not request appointment of a receiver, perhaps because it viewed the prospect of a meaningful recovery of funds as unlikely.  

One of the largest sources of recovery for victims of Ponzi schemes typically comes from lawsuits against fellow investors who were fortunate enough to ultimately profit from their investments either through an extended investing horizon or the receipt of "commissions" or "bonuses" for recruiting other investors.  Aptly known as "clawback" suits in Ponzi jurisprudence, the suits seek recovery of fictitious profits consisting of amounts in excess of that investor's net investment in the scheme.  Because the scheme operator does not generate the promised returns from legitimate activities, these transfers are nothing more than the redistribution of new investor funds.  While extensive caselaw generally recognizes that clawback targets can keep the amount of transfers adding up to their total investment in the scheme (absent signs that the investor did not act in good faith in receiving the transfers), the law is clear that any receipt of funds over an investor's net investment can be recovered as "false profits."  

One of the "net winners," as they are known, in Galemmo's scheme was Michael Willner.  Willner was one of Galemmo's original investors, whose initial investment of several million dollars allegedly multiplied several times according to fictitious account statements provided by Galemmo.  Willner also allegedly served as a recruiter for new Galemmo investors, and the lawsuit alleged that Galemmo paid commissions to Willner for referred investors.  Willner allegedly withdrew "millions" of dollars in excess of his original investment.

Willner sent out an incriminating email to fellow investors in the days after Galemmo's announcement that the funds would be shutting down, stating: 

“To those of you that I brought into the fund you have my deepest and most sincere apologies...I am embarrassed and shamed by my actions. Like most of us I ignored the poor statements and lack of transparency in favor of the high returns. In hindsight, these warning signs should have alerted me to probe deeper and ask appropriate questions.

While Willner allegedly received "millions" in excess of his original investment, he later settled the suit for $1.4 million.  

Claims Process

Lawyers representing the victims say that a claims process will have to be administered in order to accurately distribute the funds to the over-150 investors who might be eligible to share in the recovered funds.  It is likely that each investor will receive a pro rata share of the $3.4 million, meaning that each would stand to recover approximately 10% of his/her losses based on previous government estimates of a total of nearly $35 million in losses.  

The law firm behind the lawsuit, Santen & Hughes, was the same law firm that filed the initial lawsuit accusing Galemmo of running a fraud in the wake of the scheme's collapse.  The firm has also filed other lawsuits against third parties seeking recovery for Galemmo victims, including a suit against several prominent financial institutions related to their dealings with Galemmo.  The firm was able to interview Galemmo before he reported to federal prison, and it is possible that other net winners could be pursued.  


Supreme Court Rejects Time-Based Damages For Madoff Victims 

The U.S. Supreme Court refused to hear an appeal over whether victims of Bernard Madoff's historic Ponzischeme were entitled to an inflation-based upward adjustment of their losses, freeing approximately $1 billion for future distributions to victims and bringing finality to an appellate court's decision earlier this year dismissing such an adjustment.  Trustee Irving Picard indicated in a statement issued today that he intends to "immediately" move forward with making a sixth distribution to investors, who have already recovered over 50% of their net losses to the notorious conman.  Assuming Picard wins approval from the bankruptcy court for such a distribution, all investors with losses of $1.13 million or less will have recovered 100% of their losses.  Further, given that this marked the last major appeal facing the bankruptcy estate, the focus may soon turn to resolving pending litigation and winding down the estate.  

The Appeal

In the aftermath of a Ponzi scheme, a claims process is often instituted to return recovered assets to victims on a pro rata basis based on approved losses.  While a victim's claim is often decreased based on the amount of payments or distributions they received from the scheme during its existence, some of Madoff's victims took the position that they were entitled to an upward adjustment accounting for inflation during the period of their investment and/or interest to reflect the time-value of money.  As the Second Circuit characterized the victims' position, 

the claims of Madoff’s earlier investors are unfairly undervalued when compared to the claims of Madoff’s later investors.

Under the statutory framework of the Securities Investor Protection Act ("SIPA"), which governed the liquidation of Madoff's brokerage, the Second Circuit concluded that 

an inflation adjustment to net equity is not permissible under SIPA.  An inflation adjustment goes beyond the scope of SIPA’s intended protections and is inconsistent with SIPA’s statutory framework.

The Second Circuit gave weight to the absence of an inflation-based adjustment from SIPA's provisions, noting that such a provision would be "nonsensical" given SIPA's intended purpose to remedy broker-dealer insolvencies rather than the outright fraud committed by Madoff.  Rather, SIPA aims to restore investors to their position had a liquidation not occurred.

Notably, the Securities and Exchange Commission supported the victims' position - and opposed the trustee - that SIPA permitted inflation-based adjustments.  The Second Circuit concluded that this position was not entitled to any deference typically afforded to administrative interpretations, and remarked that the Commission's interpretation was "novel, inconsistent with its positions in other cases, and ultimately unpersuasive."  Indeed, the Court observed that that, while favoring an inflation-based adjustment in this case, the Commission had recently opposed such an adjustment in a "different, long-lasting Ponzi scheme."  Given that both scenarios envisioned an outcome where recovered assets would ultimately be insufficient to fully satisfy investor claims, the Second Circuit rejected any basis to further exacerbate this shortfall.

Perhaps inherent in such an outcome urged by the victims and the Commission is the result that victims that invested longer in the scheme would be entitled to a larger total claim based on the upward adjustment - an outcome which, assuming there were not enough funds to satisfy all investor claims, would result in a proportionate decrease in funds available to investors with shorter investment durations.  A policy argument opposing such a position would suggest that to do so would essentially add a degree of moral hazard in providing less of an incentive for a long-term investor to question the returns they were receiving or perform adequate due diligence.  Further, considering that Madoff's scheme lasted decades, an inflation-based adjustment of even 2%-3% annually could mean a significant increase for a long-term investor - an increase which would ultimately be borne by shorter-term investors.  

A copy of the Second Circuit's Order is below:


Madoff Opinion



Self-Described "Idiot" Charged With $1.5 Million Ponzi Scheme

A New Jersey man was charged with multiple violations of federal securities laws for operating what authorities allege was a Ponzi scheme that duped investors out of over $1.1 million.  William Wells, along with his company, Promitor Capital Management, LLC ("Promitor"), was named in a complaint filed in a New York federal court by the Securities and Exchange Commission.  The Commission is seeking disgorgement of ill-gotten gains, imposition of civil monetary penalties, injunctive relief, and pre-judgment interest.  In a parallel action, Wells was also named in a criminal complaint filed by the U.S. Attorney's Office for the Southern District of New York.

Wells founded Promitor in 2009, soliciting friends and colleagues to invest in a fund that would primarily engage in long trading of equity securities.  According to a Fund Overview distributed to certain investors, Promitor sought to "achieve returns exceeding those of the BarclayHedge Event Driven Index by 25%" through the use of options strategies and capitalizing on market sentiment prior to market-moving events such as earnings announcements.  The Fund Overview also advertised that Wells was a Registered Investment Advisor.  Wells and Molitor maintained several brokerage accounts at TD Ameritrade and USAA, and raised at least $1.3 million from investors.  

However, Wells was not a Registered Investment Advisor and had never taken any examination to attain the title.  Nor did Wells cause Molitor to engage in the trading patterns advertised in the Fund Overview.  Indeed, instead of placing long-term trades in a basket of equity securities, Wells engaged in a series of short-term, high-risk, options trades that resulted in total losses exceeding $500,000.  According to the Commission's Complaint, which is embedded below, Wells suffered annual trading losses from 2009 to 2015  

Despite these trading losses, Wells allegedly caused Molitor to make the promised payments to investors beginning in 2012.  Given Wells' poor investing results, the payments to investors were paid using funds from other investors - a classic hallmark of a Ponzi scheme.  Wells ultimately paid out at least $319,000 in purported interest payments to investors.  During that time period, Wells also transferred at least $39,000 to his own personal account.  

According to the Commission, Wells' scheme began to collapse in early 2015 in the face of mounting redemption requests from investors.  Indeed, as of February 24, 2015, Promitor had a balance of -$2.76 in its brokerage accounts and $97.72 in its checking account.  In a text-message exchange between Wells and an unnamed investor reproduced in the Commission's Complaint, Wells offered a varying litany of excuses concerning his inability to satisfy that investor's redemption request, ultimately resulting in that investor's inquiry whether Wells was "running a Ponzi scheme?"  Wells later admitted that:

My explanation is that I'm an idiot and was trying to get some big trades to [h]it...To make you more money.

The Commission's Complaint is below:


comp-pr2015-226 by jmaglich1



Banker Tied To Rothstein's Massive Ponzi Scheme Will Plead Guilty

Just before his trial was scheduled to begin next month, a former TD Bank vice president will plead guilty to a wire fraud conspiracy charge related to his relationship with convicted Ponzi schemer Scott Rothstein.  Frank Spinosa, 54, is scheduled to plead guilty to a single count of wire fraud conspiracy on October 8, 2015.  Spinosa had been scheduled to stand trial next month, where he could have been sentenced to dozens of years in prison if convicted on all charges.  Instead, Spinosa faces a maximum five year sentence for wire fraud conspiracy.   

Rothstein's relationship with Spinosa began after he opened over 20 attorney trust accounts and law firm operating accounts in late 2007 at TD Bank and another bank later acquired by TD Bank.  Spinosa was Rothstein's point of contact beginning in 2008, and communicated often with Rothstein regarding the accounts and various documents that were provided to investors.  As Spinosa's compensation was tied to the size and volume of accounts he managed, the fact that Rothstein's accounts were among TD Bank's largest accounts in South Florida meant increased compensation and bonuses for Spinosa.  

Spinosa was implicated in the massive scheme by Rothstein himself, who claimed during a 2011 deposition that he had recruited Spinosa to assist in the preparation of false "lock letters" used to show investors that their investments were safe and that Rothstein could not remove funds from the account holdings the funds. According to the Securities and Exchange Commission, which filed civil fraud charges against Spinosa last year, Spinosa also made oral assurances to at least two investors that certain trust accounts at TD Bank holding investor funds contained hundreds of millions of dollars when in reality the "locked" accounts typically held less than $100.  In one instance during August 2009, months before the scheme eventually collapsed, Spinosa participated in a conference call with Rothstein and an investor in which he told the investor that an account had a balance of $22 million when, in reality, the account had a balance of less than $100.  The investor subsequently made four more investments with Rothstein in the ensuing months.

Spinosa is the last remaining defendant to not be sentenced, and his sentencing will mark the culmination of an extraordinary series of prosecutions that ultimately put over two dozen individuals in prison for their role in Rothstein's fraud.  With no remaining prosecutions on the horizon, it is widely believed that Rothstein will press his sentencing judge for a reduction in his 50-year term based on his extensive cooperation.  Ponzitracker recently covered this issue in depth here

Other Ponzitracker coverage of the Rothstein scandal is here.


Victims of $200 Million Ponzi Scheme Set To Recover 9% Of Losses

Nearly six years after a raid by the Federal Bureau of Investigation uncovered a $200 million Ponzi scheme masterminded by Tim Durham, a bankruptcy trustee tasked with recovering funds for scheme victims has announced his intention to make a first distribution representing 8% - 9% of victim losses.  Victims of Fair Finance Company ("Fair Finance") will share a collective $18 million distribution, the bankruptcy trustee recently announced, which would represent just pennies on the dollar compared to the over $200 million in claims submitted by scheme victims.  Durham received a 50-year prison term for the scheme, while co-conspirators Jim Cochran and Rick Snow were sentenced to terms of 25 years and 10 years, respectively. It does appear that victims stand in line to receive at least one more distribution based on current funds in the bankruptcy estate.

The Scheme

Durham ran Fair Finance from 2005 through November 2009, with Cochran serving as Chairman and Snow serving as chief financial officer.  Durham and Cochran purchased Fair Finance for $23 million in 2002, which had successfully operated for decades as a legitimate finance company that purchased finance contracts between businesses and their customers that carried annual interest rates ranging from 18% to 24%.  Fair Finance would then profit off the difference between the purchase price and the money collected from the arrangement.  Purporting to continue the historically profitable business, Durham and Fair Finance raised approximately $230 million from the sale of investment certificates to over 5,000 investors.  

However, rather than continuing Fair Finance's business, Durham modified the business structure and began using a steadily increasing amount of investor proceeds to make "loans" for a number of unauthorized purposes, including financing Durham and Cochran's unprofitable businesses, paying fictitious interest to investors, and enriching themselves and those close to them.  By 2009, these 'loans' totaled more than $200 million and constituted more than 90% of Fair Finance's supposed investments.  Essentially looting the company, Durham and Cochran saddled Fair Finance with hundreds of millions of dollars in subordinated debts, while at the same time funneling money out of the company to themselves, to struggling companies they had an ownership interest in, and to pay their daily living expenses and sustain their lavish lifestyles.  These living expenses included more than 40 classic and exotic cars worth over $7 million, a $3 million private jet, and a $6 million yacht in Miami. 

The company was eventually forced into involuntary bankruptcy, and a grand jury indicted Durham, Cochran and Snow in March 2011.  Maintaining their innocence, the men were later convicted at trial, and prosecutors sought a 225-year sentence for Durham who they labeled the "greediest, most selfish, and remorseless" Ponzi schemer.  At sentencing, U.S. District Judge Jane Magnus-Stinson handed down a 50-year sentence to Durham, remarking that she considered the punishment an "effective" life sentence.  While Durham achieved a small victory when a federal appeals court threw out two of his wire fraud convictions, he was subsequently resentenced to the same 50-year term this summer.

Claims Process

Scheme victims initially submitted over 5,000 claims with collective losses pegged at nearly $230 million.  The trustee, Brian Bash, indicated that over 1,000 of those claims had overstated victim net losses, and last week's court filing puts the total amount of claims at approximately $208 million.  According to the filing, there is approximately $43 million currently in the bankruptcy estate.  This comes after the court recently approved a $35 million settlement with Fortress Credit, which had provided financing to Fair Finance and which was accused by Bash of ignoring warning signs that Fair Finance was operating a massive fraud.  If the proposed settlement is approved, roughly $24.2 million will remain in the bankruptcy estate.  

Interestingly, the initial bankruptcy judge presiding over the case invoked what is known in her district as the "White Rule."  That informal rule, named after former bankruptcy judge Harold White, required that at least half of funds recovered in a bankruptcy estate should be returned to the victims.  In other words, this served to cap the amount of funds used by the estate to maintain or liquidate the businesses as well as compensate professionals involved in the case.  U.S. Bankruptcy Judge Marilyn Shea-Stonum, who is now retired, announced in late 2013 that it was her intention to invoke the "White Rule" with respect to whatever funds the Fair Finance trustee was able to recover.  Judge Shea-Stonum retired in late 2013, so it remains to be seen whether the current judge will follow a similar path.