When a Cincinnati money manager's $100 million Ponzi scheme collapsed over three years ago, authorities seemingly acknowledged the bleak prospects of recovery in declining to seek appointment of a receiver to marshal and gather assets for victims. Galemmo, a former purported savvy trader who touted consistent gains amidst market turmoil, quickly pleaded guilty and received a 15-year prison sentence. With the seizure of several million dollars in Galemmo's assets held up on appeal, victims' sole hope for any recovery rested on an unlikely scenario: compelling other 'victims' who profited from their investment during the scheme to turn over those profits to be collectively divided among the less fortunate victims. With the assistance of a Cincinnati law firm, those victims have started to see results.
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.
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" based on the investment of others they referred to the scheme. 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."
The Cincinnati law firm of Santen & Hughes began pursuing those "net winners," as they are called in Ponzi jurisprudence, for their false profits from Galemmo's scheme. One net winner, Michael Willner, settled for $1.4 million after he sent the following email to Galemmo investors in the immediate aftermath of the scheme's collapse:
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.
One married couple settled for $327,000 while another investor and an associated company agreed to pay $386,000 to resolve a clawback suit. Late in 2015, the Santen & Hughes lawyers sought court approval to distribute a total of $3.4 million to Galemmo's victims that represented the proceeds of clawback settlements. Based on the government's estimate that Galemmo's victims suffered approximately $35 million in net losses, the distribution represented a recovery of roughly 10% for victims. Coupled with another distribution in 2016, victims have received a total of $5.2 million to date - roughly 15% of their losses.
A Cincinnati judge recently entered a $865,000 judgment against another net winner. Combined with another $450,000 in judgments entered against three other net winners, victims can now expect to receive an additional $1.3 million in distributions. Combined with the estimated $6 million in assets seized by the government, it appears that the efforts of Santen & Hughes will be partly responsible for returning nearly 25% of victims' losses. Any further recovery will be directly dependent on the firm's ability to identify additional net winners and any other third parties that played a role in the scheme.