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Monday
Oct052015

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.  

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