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Recent SEC Releases
Wednesday
Nov012017

SEC Investigating Mortgage Company That Raised $1 Billion From Investors

The Securities and Exchange Commission has asked a Miami federal judge to enforce subpoenas against nearly 250 companies affiliated with Woodbridge Group of Companies, LLC ("Woodbridge") in connection with the Commission's investigation into whether "the company is perpetrating a fraud on its investors."  In a proceeding filed today seeking an order compelling the production of various financial- and investor-related documentation, the Commission disclosed its ongoing investigation into Woodbridge's receipt of more than $1 billion in investor funds relating to various real-estate offerings.  The move comes after the Commission successfully brought a similar action against Woodbridge after the company refused to produce any of its emails and several officers, including CEO Robert Shapiro, invoked their Fifth Amendment rights in sworn investigative testimony.   

According to the Commission, Woolbridge, based in Sherman Oaks, California, has raised over $1 billion from thousands of investors nationwide through various products offered for investment.  These products include the First Position Commercial Mortgage ("FPCM"), which the company describes as:

 “[a] private third-party loan to Woodbridge [which] provides higher returns with shorter terms secured by commercial real estate. Private lenders select a commercial mortgage in Woodbridge’s inventory to serve as collateral for their private loan. They are recorded on title and acquire a first lien position on the mortgage. And every lender is paid monthly interest from the moment they loan to Woodbridge at a fixed annual 5% interest with a return of principal at the end of the one-year term.” 

In other words, investors loan money to Woodbridge which purportedly uses those funds to acquire properties and in return pays investors a 5% annual return as well as records those investors on the property title. According to the Commission, Woodbridge forms a limited liability company for each one of the properties it acquires in order allegedly for liability purposes.  Woodbridge also raises money using investment offerings through entities such as Woodbridge Mortgage Investment Fund III, LLC.

The Commission began investigating Woodbridge in September 2016 for what it described as "possible significant violations of the securities laws," including "the offer and sale of unregistered securities, the sale of securities by unregistered brokers, and the commission of fraud in connection with the offer, purchase, and sale of securities."  While the Commission first informally reached out to the company to request documents in late 2016, the lack of any response forced the Commission to issue a formal subpoena for certain documents including email correspondence between Woodbridge principals, investors, and sales agents.  While Woodbridge produced documents in response to the subpoena, the Commission took issue with its failure "to produce many of the requested documents critical to the investigation."  In addition,

Many key witnesses, including, but not limited to, Mr. Shapiro, D.R., Woodbridge’s Managing Director of Investments, and N.P., Woodbridge’s Controller, have invoked their Fifth Amendment rights in sworn investigative testimony, and have thus refused to answer any substantive questions or provide any of their e-mails. 

The Commission then provided several prioritized requests for certain documents, including emails, but was informed by Woodbridge's counsel that only one person at the company was available and capable of searching for emails and that the company could not afford to contract with a third-party vendor.  After Woodbridge's counsel attempted to meet with senior leadership at the Commission to discuss the investigation, the Commission filed an action in July 2017 seeking to compel Woodbridge's compliance with the subpoena.  The Court granted that request on September 20, 2017, ordering Woodbridge to produce responsive documents and emails using Court-ordered search terms.   

In connection with the discovery that Woodbridge formed separate companies to purportedly hold their commercial properties, the Commission sent out subpoenas to the 236 LLCs it had identified. The Commission alleged that:

The 236 LLC subpoenas sought basic information about the formation, ownership and bank account information about the LLCs, in order to garner further insight into their affiliation and connection with Woodbridge and its President, Robert Shapiro. However, despite service of the subpoenas, and demand letters sent approximately six-weeks later, the Commission has not received a response from 235 of the LLCs. 

According to the Commission, its investigation demonstrated that "many, if not all, of these LLCs may be Woodbridge affiliates with Shapiro as their Manager."  The 235 subpoeaned LLCs failed to respond to the Commission's subpoenas, and the Commission filed an action yesterday seeking to compel their compliance.

A quick Google search shows that several state securities regulators have investigated various Woodbridge entities.  For example, several Woodbridge Mortgage Investment Fund entities entered into a consent order in May 2015 with the Massachusetts Securities Division in which the entities neither admitted nor denied that they had sold unregistered securities, agreeing to cease selling unregistered securities to Massachusetts residents, offering rescission to those investors, and also agreeing to pay a $250,000 civil penalty.  Similarly, the Michigan Department of Licensing and Regulatory Affairs recently issued a Notice and Order to Cease and Desist in August 2017 to Woodbridge Mortgage Investment Fund II, LLC, ordering the entity to cease and desist from selling unregistered securities and from omitting to state material facts. 

A copy of the Commission's Application is here.

Monday
Feb132017

For Galemmo Ponzi Victims, Recovery Chances Depend On Clawbacks 

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.

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.

Clawbacks

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.  

Monday
Feb132017

Zeek Rewards Mastermind Sentenced To Nearly Fifteen Years In Prison

The North Carolina man who drew comparisons to Bernard Madoff for his operation of a Ponzi scheme that duped tens of thousands of victims out of nearly $1 billion learned from a federal judge today that he, like Madoff, will likely spendthe rest of his life in federal prison.  Paul Burks, 70, was sentenced by U.S. District Judge Max Cogburn Jr. to a term of fourteen years and eight months, largely in line with the range urged by prosecutors following Burks' conviction on four fraud and conspiracy counts.  As Judge Cogburn observed, Burks "is essentially facing a life sentencing given his health conditions," which include multiple infirmities such as diabetes, prostate cancer, and mild dementia.  The sentence is approximately twice as long as the 90-month term previously handeddown to former ZeekRewards COO Dawn Wright-Olivares.  

Burks operated Rex Venture Group, LLC ("RVG") since 1997.  In 2010, he formed zeekler.com, which operated as a penny auction website offering participants the ability to place bids on merchandise in one-cent increments.  Individuals were required to purchase "bids" in lots, usually at a cost of $.65 per bid, in order to participate in the auctions.  Burks launched ZeekRewards in January 2011 as an "affiliate advertising division" of Zeekler.  Participants were then solicited to become investors, or affiliates, in ZeekRewards in the form of investment contracts called the "Retail Profit Pool" and the "Matrix."  None of these investments were registered with the SEC or any state regulatory authorities.

The Retail Profit Pool promised investors the chance to earn lucrative daily returns of "up to 50% of the daily net profits" after completing a process that involved enrolling in a monthly subscription plan, soliciting new customers, selling or purchasing ten Zeekler.com "bids", and placing one free ad daily for Zeekler.com.  According to the ZeekRewards website, a daily commitment of "no more than five minutes per day" was required to share in daily profits.  The daily "award" was usually 1.5% of the individual's 'investment'.  Due to the compounding nature of these "Profit Points", as they were called, the cumulative amount of outstanding Profit Points numbered nearly $3 billion in August 2012 when the Securities and Exchange Commission filed an emergency action to halt the ongoing fraud.  Assuming a 1.5% daily "award", the outstanding Profit Points would have required daily cash outflows of $45 million should all investors seek to receive their "award" in cash.  

In addition to the Retail Profit Pool, investors could also participate in the "Matrix", which was a form of multi-level marketing that rewarded investors for each "downline" investor within that investor's "Matrix".  The Matrix consisted of a 2x5 pyramid, and each person added to an investor's Matrix qualified that investor to receive a bonus.  

While ZeekRewards represented to investors that the operation was extremely profitable, in reality, the company's revenues and payments to investors were derived solely from funds contributed by new investors - a classic hallmark of a Ponzi scheme.  Indeed, authorities alleged that 98% of all incoming funds were derived from the funds of new investors. Thus, the scheme could only stay afloat so long as new investor contributions were sufficient to satisfy the amount of outflows.  However, because investors were actively encouraged to "roll-over" their "profit points" back into the scheme, the number of outstanding liabilities to investors steadily increased, reaching approximately $2.8 billion in August 2012 despite available cash reserves of less than 4300 million.  Due to the likelihood that those funds would soon be exhausted, the Commission initiated an emergency enforcement proceeding and sought an asset freeze in August 2012.

Burks, as principal of Rex Ventures and Zeek Rewards, is alleged to have withdrawn over $10 million in investor funds for the benefit of himself and his family members.  

After a number of delays, a Charlotte jury convicted Burks of all counts in July 2016 following a two-week trial.

The court-appointed receiver, Kenneth Bell, anticipates makinga third distribution to victims in March 2017 that will result in all victims recouping between 60% and 75% of their net losses.  This recovery marks one of the highest ever achieved by Ponzi victims.  

Monday
Oct172016

Another Cay Clubs Principal Indicted On Bank Fraud And Tax Charges

A Florida man is facing bank fraud and tax charges for his involvement in the alleged $300 million Cay Clubs Ponzi scheme, making him the third person to be criminally charged in what was one of the largest schemes in Florida history.  David Schwarz, 60, is facing one count of conspiracy to commit bank fraud, three counts of bank fraud, three counts of false statements to a financial institution, and one count of interference with the administration of the IRS.  Each of the conspiracy and bank fraud offenses carries a maximum 30-year term, while the interference offenses each carry a maximum three-year term.  Schwarz has been freed on bond, which interestingly was immediately appealed by prosecutors.  

Cay Clubs Scheme

Cay Clubs operated from 2004 to 2008, marketing the offering and sale of interests in luxury resorts to be developed nationwide.  Dave Clark served as Cay Clubs' chief executive officer, while his wife Cristal Clark served as a managing member and the company's registered agent.  Schwarz served as CFO of Cay Clubs.  Through the purported purchase of dilapidated luxury resorts and the subsequent conversion into luxury resorts, Cay Clubs promised investors a steady income stream that included an upfront "leaseback" payment of 15% To 20%.  In total, the company was able to raise over $300 million from approximately 1,400 investors.

However, by 2006 the company was alleged to have lacked sufficient funds to carry through on the promises made to investors.  Instead of using funds to develop and refurbish the resorts, Cay Clubs allegedly used incoming investor funds to pay "leaseback" payments to existing investors in what authorities alleged was a classic example of a Ponzi scheme.  While the Securities and Exchange Commission initiated a civil enforcement action in January 2013 against Schwarz and others alleging that the company was nothing more than a giant Ponzi scheme, the litigation came to an abrupt end in May 2014 when a Miami federal judge agreed with the accused defendants that the Commission had waited too long to bring charges and dismissed the case on statute of limitations grounds.  

Authorities subsequently filed criminal charges against Dave and Cristal Clark, seemingly unrelated to the Cay Clubs fraud and instead stemming from the Clarks' operation of an unrelated scheme to siphon money from their operation of a series of pawn shops throughout the Caribbean. Several months later, authorities filed bank fraud charges related to the Clarks' interaction with lenders as part of their operation of Cay Clubs - a strategy seemingly designed to ensure the charges would withstand any statute of limitation challenges given that bank fraud carries a 10-year statute of limitations.  

After a five-week trial in Summer 2015, a federal jury deliberated for four days before acquitting Cristal Clark of all charges and deadlocking on the charges against Dave Clark.  After the mistrial, prosecutors retooled their strategy by shifting their focus from the misrepresentations made to investors to the obtaining of loans from financial institutions in creating artificial sales transactions.  After a December 2015 retrial, Dave Clark was convicted on all charges and subsequently sentenced to a 40-year prison sentence.  

Schwarz Charges

In the indictment filed on October 11, 2016, authorities alleged that Schwarz was a 1/3 owner of Cay Clubs and used his relationship with Dave Clark to conspire to divert loan proceeds obtained using straw borrowers and fraudulent loan applications.  The indictment indicates that Schwarz and Clark would use various Cay Clubs corporate entities to orchestrate sales of condominiums to certain Cay Clubs employees and family members. The pair allegedly executed false and fraudulent loan applications, which included representations indicating that cash to close would be provided by the purported borrower to secure the mortgage loan.  The applications also included false information about the straw borrowers' employment, wages, and financial situation.  In turn, the mortgage loans that were extended based on these representations were subsequently deposited into Cay Clubs accounts and used to perpetuate the fraudulent scheme.  

Clark and Schwarz also allegedly shared in the loan proceeds while taking elaborate steps to conceal these distributions.  This included paying Clark's salary to a third party and failing to issue a corresponding W-2 or 1099 to Clark, failing to issue any K-1 to Schwarz or Clark for any of the transfers or distributions, failing to file IRS partnership returns for the Cay Clubs entities, filing false tax returns with the IRS understating their receipts from Cay Clubs, and providing false testimony to the Commission.  

Bond Issues

After Schwarz was arrested in Orlando last week, he appeared before a U.S. Magistrate Judge to ask for a bond governing the conditions of his release.  That magistrate judge entered an order granting bond to Schwarz that was "substantially lower than that requested by the government," providing that Schwarz could use his residence as collateral for the large majority of the $500,000 bond.  The government immediately filed an appeal, taking issue with Schwarz being permitted to use his house as collateral given evidence that Schwarz paid off more than $200,000 of the residence using fraudulent scheme proceeds.  

In their motion, the government reproduced a calculation of the potential sentencing guidelines if Schwarz was convicted of any of the bank fraud charges, indicating that the resulting calculation would be life in prison.  Alleging that Schwarz received a large amount of money that remains unaccounted for, the government requested a $250,000 surety bond with the added condition that Schwarz be required to demonstrate that the source of the funds is legitimate and not tied to criminal proceeds.  According to court notes, it appears that the government reached an agreement with Schwarz' counsel today at a hearing.

A copy of the Indictment and Appeal of Bond Order are below:

 

Schwarz Indictment by jmaglich1 on Scribd

 

 

Bond Appeal by jmaglich1 on Scribd

 

Tuesday
Jun282016

Government Cries Foul Over Alleged Ponzi Mastermind's Recently Discovered "Handwritten Notebooks"

As trial nears for a North Carolina man accused of running one of the largest Ponzi and pyramid schemes in history, the government has raised questions over the defendant's intention to use recently-disclosed "handwritten notebooks" that, while allegedly dating back to 2011, were never turned over or otherwise disclosed to the government.  Paul Burks, 69, was indicted in October 2014 on multiple fraud charges over his operation of ZeekRewards, which the Securities and Exchange Commission had previously accused of being a Ponzi and pyramid scheme that duped tens of thousands of victims out of hundreds of millions of dollars.  

ZeekRewards was an online penny auction website that attracted users at an exponential pace due to a lucrative investment program that promised annual returns exceeding 200% and provided incentives for participants to recruit new investors.  The program, allegedly masterminded by Burks, attracted over one million participants before the Commission filed an emergency enforcement action in August 2012 alleging the venture was a massive Ponzi and pyramid scheme.  After a receiver was appointed, a subsequent investigation revealed that over 700,000 participants suffered collective losses exceeding $700 million.
 

As Burks and the government prepare for trial, a trial that has already been delayed several times due to the massive amount of documentary and computer evidence, the government has made several requests to limit or exclude Burks from using certain evidence.  These requests, known as motions in limine, ask the court to rule in advance of trial on certain evidence that might be prejudicial, irrelevant, or inadmissible.  On June 28, 2016, the government filed a Motion in Limine Regarding Defense Experts (the "Motion"), asking the court to limit Burks' use of recently-produced "Handwritten Notebooks" that were marked as an exhibit Burks intended to use at trial.

As the Motion explains, Burks first disclosed in April 2016 that he had discovered notebooks containing his handwritten notes and impressions during 2011 - a time when authorities allege that ZeekRewards was a full-blown Ponzi and pyramid scheme that was growing exponentially and taking in hundreds of millions of dollars from unwitting participants.  The government highlights the convenience of this revelation, noting that Burks had not disclosed the existence of the notebooks despite receiving a grand jury subpoena, testifying before the grand jury that he had produced everything to the best of his knowledge, and being ordered by the court to turnover all relevant discovery.  As the Motion notes,

There can be no legitimate dispute that the Handwritten Notebooks – if they actually existed on the dates they purport to have been created – were responsive to the Grand Jury Subpoena, and, thus, Defendant’s failure to produce them was in violation of that Subpoena and his testimony that he had produced all documentation responsive to the subpoena was untrue.

The Motion does not take issue with the introduction of the Handwritten Notebooks as evidence; rather, it seeks to limit the methods used to introduce the notebooks into evidence.  As the government notes, the Handwritten Notebooks factor prominently in reports prepared by experts retained by Burks in an effort to "offer (improper) opinions regarding Defendant’s state of mind at the time of the offense."  While the contents of the notebooks and the accompanying expert reports are unknown, it is likely that they are in contrast with the government's burden to demonstrate that Burks had criminal intent.  The Motion argues that, before the Handwritten Notebooks may be referenced by other witnesses, they must first be introduced through and authenticated by Burks himself through his testimony.

The motive for the government's position becomes clear: Burks is faced with the choice of whether or not to testify at trial.  There is no obligation for a defendant to testify on his or her own behalf, and that decision cannot be used as a factor for conviction or acquittal by the jury.  Anecdotal evidence suggests that the majority of criminal defendants are advised by their counsel not to testify at trial on the theory that the government has failed to prove their case beyond a reasonable doubt.  The government argued that presenting Burks with such a choice is consistent with pertinent caselaw, quoting authority that "a defendant’s rights would not be violated simply because he had to choose between not testifying and laying [the required] foundation."  

The Motion also suggests that Burks could be subject to contempt proceedings for his failure to produce the notebooks.  

A copy of the Motion is below.  As always, Ponzitracker is grateful to ASDUpdates for monitoring the Zeek docket.

motion in limine