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Recent SEC Releases
Tuesday
Apr162013

Former College Football Coach Indicted in $80 Million Ponzi Scheme

Federal authorities unveiled criminal charges against the former University of Georgia football coach, alleging he scammed dozens of investors, including fellow coaches and former players, out of more than $80 million.  Jim Donnan, of Athens, Georgia, was charged in an eighty-five count indictment that also named his former business partner, Gregory L. Crabtree.  The criminal charges come less than a year after the U.S. Securities and Exchange Commission ("SEC") filed civil charges against the men.  Both men were released on $25,000 bond, and ordered to restrict their travel plans and surrender their passports.

Donnan and Crabtree operated GLC Limited ("GLC"), also known as Global Liquidation Center, which was formed in 2004 and purported to be in the wholesale liquidation business.  Beginning in 2007, the men solicited potential investors, promising short-term returns ranging from 50% to 200% from the purchase and resale of discontinued or damaged merchandise acquired from major retailers at a discount, which ranged from out-of-season toys, patio furniture, or holiday decorations.  Donnan was in charge of attracting investors, using his contacts from his previous tenure as head football coach of the University of Georgia to recruit fellow coaches and former players.  In total, nearly 100 investors contributed over $80 million to the scheme.   

However, out of the $80 million raised from investors, slightly more than 10% was used to purchase merchandise for resale, and the company booked less than $6 million in total sales.  The remainder, or nearly $64 million, was used to make payments of purported interest and principal redemptions to investors.  Crabtree and Donnan also misappropriated millions of dollars of investor funds, with Crabtree profiting by approximately $1.6 million and Donnan taking home more than $13 million on an initial $4.7 million investment.  Donnan's family is also said to have profited by over $1 million from the scheme.  When GLC began falling behind on interest payments, a group of investors obtained the appointment of a Restructuring Officer, who discovered the fraud and, in February 2011, caused GLC to file a voluntary bankruptcy petition.  Donnan and his wife also filed for personal bankruptcy following increasing claims from GLC victims.

According to Donnan's attorney, the failed business venture wiped Donnan out financially, but maintained that "there is no criminal intention here."  

Donnan enjoyed a storied career in college football, leading Marshall to a national championship and later being inducted to the College Football Hall of Fame.  

Monday
Apr152013

Indian Regulators Warn Public of Goat-Raising Ponzi Scheme

Indian regulators have issued an alert to residents warning of a Ponzi scheme that promises lucrative returns in echange for investing in a goat-rearing venture.  Citizens of the Jammu and Kashmir province, the northermost state in India, were advised to steer clear of the Sheep Husbandry Department, which is advertising 2% monthly returns from an investment in goat-rearing farms. Ironically, the scheme comes just months after investors were warned of a similar scam also seeking investors for goat-rearing farms.

According to the Securities and Exchange Board of India ("SEBI"), Sheep Husbandry Department ("SHD") has solicited investments from the public basd on claims that its goat-rearing farms could double investors' money in 3-4 years by offering 2% monthly returns.   SEBI has opened an investigation, with details about the number of affected investors or estimated losses unavailable.

SEBI warned investors about a similar scheme in November 2012, opening an investigation into the Beetal Livestock & Farm (P) Ltd ("Beetal").  Beetal took out advertisements in local newspapers to solicit potential investors, who were told that they also could double their money in several years by offering consistent monthly returns.  For example, with an initial investment of several thousand rupees, an investor would purchase a goat.  Investors were told that an average goat had four kids per year, which offered the possibility of exponential returns through subsequent births by those offspring in later years.  The masterminds of Beetal did not cooperate with investigators, and are suspected to be on the lam.  

Surprisingly, such schemes are not uncommon in India, where unconventional investments such as livestock or farm animals have been the subject of similar schemes.  For example, a Ponzi scheme centered around raising emus recently collapsed, with thousands of investors facing up to $50 million in losses.  There, a company known as Susi Emu Farms ("Susi") promised investors a steady stream of income in return for raising an Emu chick.  After two years, investors were given the chance to "exchange" their two-year old Emu for another Emu chick.  A VIP program soon followed, in which investors could receive a similar return while Susi took on the obligation of raising the emu.  Word quickly spread of the dependability of the promised returns, and an advertising campaign headlined by popular Indian film stars quickly made Susi a household name.  The operation soon spread throughout India, gaining thousands of investors. When the scheme collapsed, total losses were estimated to be as high as $50 million.

Wednesday
Apr102013

Court Tosses Madoff Investors' Lawsuit Against SEC

Despite the 'regrettable inaction' by the Securities and Exchange Commission ("SEC") in failing to detect Bernard Madoff's historic $65 billion Ponzi scheme, a federal appeals court ruled that those victimized by Madoff's fraud could not hold the SEC accountable for negligence.  Citing a law that protects federal agencies in the exercise of their discretionary powers, a three-judge appellate panel of the Second Circuit Court of Appeals upheld a lower court's dismissal of the lawsuit.  

Investors brought the lawsuit after a highly critical report by the SEC's inspector general that highlighted a myriad of missed opportunities to detect Madoff's fraud at an earlier stage that could have prevented billions of dollars in losses.  This included several reports by Harry Markopolos, an independent financial fraud investigator who raised questions regarding the legitimacy of Madoff's operation.  These claims went largely unheeded, aided by an inter-office communication system that effectively impeded the flow of information between various SEC branch offices. This disconnect between branch offices was highlighted in the Second Circuit's opinion, which noted:

“As a result of the S.E.C.’s repeated failure to alert other branch offices of ongoing investigations, properly review complaints and staff subsequent inquiries, and follow up on disputed facts elicited in interviews, the S.E.C. missed many opportunities to uncover Madoff’s multibillion-dollar fraud.”

Following the report by the inspector general, the SEC took extensive steps not only to discipline those responsible for failing to detect Madoff, but also orchestrated a massive overhaul of the way the agency deals with the receipt of tips and complaints.  After the internal watchdog's report was filed, the SEC hired an outside Washington law firm to recommend disciplinary action against any employees associated with Madoff's fraud.  By law, the SEC is prohibited from disciplining former employees, and the decision to terminate any employee must come directly from the agency's human resource director.  The law firm's investigation ultimately recommended the termination of one employee unless that would have an adverse effect on the agency's work.  That employee was ultimately suspended for thirty days without pay, demoted, and had their pay decreased.  Seven other employees were also disciplined, with punishments ranging from a seven-day suspension to pay reductions.

The SEC also focused on encouraging the flow of information between its regional offices, enacting reforms that dealt mainly with the inflow of tips and complaints from the public.  Under the previous system, access to tips and complaints was limited to the specific branch office where originally received.  Thus, a complaint received at the Boston office was essentially inaccessible to any other regional office for review or dissemination to other employees.  In March 2011, the SEC implemented a Tips, Complaints and Referrals database which, known to insiders as TCR, established a database for inter-agency use.  An important addition was the new partnership with the Federal Bureau of Investigation, which allowed the agencies to cooperate on investigations.  As a result of TCR, all SEC employees are now able to view and add information once a tip or complaint is received by their office.

Earlier this year, another federal appeals court reached a similar result in dismissing a separate lawsuit filed by Madoff investors against the SEC, again finding that the suit fell within the Commission's discretionary powers and thus was shielded under an exception to the Federal Tort Claims Act.  

One of the attorneys representing the victims, Howard Kleinhendler, has vowed to appeal the issue to the United States Supreme Court.

A copy of the Report of Investigation conducted by the Office of Inspector General is here.

Monday
Apr082013

CPA Firm Facing $250,000 in Sanctions for Discovery 'Shortcomings' In Suit Over Seattle's 'Mini-Madoff'

"A finding of contempt is unusual but entirely appropriate in this case.  Moss Adams and Mr. Kallander failed to produce evidence, allowed other evidence to be destroyed and then attempted to cover it all up. Thankfully, the Court exposed the truth."
- Michael Avenatti, counsel to the bankruptcy trustee
In a stark reminder of the importance of fully complying with discovery obligations, a federal judge found the nation's 12th-largest accounting firm in contempt over its failure to produce thousands of documents to the court-appointed bankruptcy trustee tasked with recovering funds for victims of Seattle's 'Mini-Madoff'.  Moss Adams, which audited the hedge funds operated by convicted Ponzi schemer Darren Berg, was found in contempt of court by United States District Judge Karen A. Overstreet and ordered to pay civil sanctions as a result of a multi-year battle to obtain documents by the bankruptcy trustee, Mark Calvert.  Michael Avenatti, who serves as counsel to the trustee, has estimated that legal fees and costs incurred in enforcing the subpoena could be in excess of $250,000.

Authorities arrested Berg in October 2010, accusing him of operating the Seattle-based Meridian Mortgage funds ("Meridian") as the largest Ponzi scheme in Washington history, with investor losses estimated in excess of $150 million.  Shortly after Berg's arrest, the court-appointed trustee began issuing subpoenas for the production of documents to a number of third-party professionals that provided services to Meridian, including Moss Adams.  The subpoena sought documents for a ten-year period in which Berg and Meridian had been a client of Moss Adams, and was designed to gather documents to allow the trustee to reconstruct and understand Berg's massive fraud.  

Initial Discovery

Upon receiving the subpoena, Moss Adams' general counsel placed a paralegal in charge of coordinating the firm's response to the subpoena and also entrusted the audit partner in charge of the Meridian Funds - who had never responded to a subpoena - with significant responsibilities.  After gathering responsive documents, approximately 12,000 pages of documents were produced to the trustee several weeks after the subpoena was received.  Unbeknownst to all parties, this would mark the beginning of a contentious discovery dispute that would last over two years.

Several months after their initial production of documents, Moss Adams produced over 1,000 pages of billing records that were apparently not included.  Several weeks later, nearly 100 more pages of billing records were produced.  Then, six months later, another 130 pages consisting of Berg's tax returns were produced.  At this point, counsel for the trustee sent correspondence to Moss Adams' general counsel, asking for an affirmation that all responsive documents had been produced.  No response was ever received.

The Lawsuit 

Indeed, just a few weeks later, Moss Adams found itself the target of a $150 million lawsuit filed by the trustee accusing the firm of professional malpractice, negligent supervision, fraud, and violations of Washington's Consumer Protection Act.  According to the suit, Moss Adams issued clean audit/opinion letters that were touted to investors to demonstrate the legitimacy of Meridian.  However, Calvert alleged that Moss Adams failed to follow both internal and industry standards in conjunction with the audits of various Meridian funds, and turned a blind eye to numerous "red flags" associated with Berg's scheme.

More Discovery

Several months after the filing of the lawsuit, one of Calvert's attorneys contacted counsel for Moss Adams and contended that the firm had failed to comply with the subpoena.  In response, counsel for Moss Adams disagreed, calling the allegation a "totally bogus issue."  A subsequent email exchange resulted in Moss Adams' counsel expressing his belief that all responsive documents had been turned over.

In October 2012, Moss Adams produced 70 pages of emails, as well as one voicemail, that had apparently inadvertently not been produced.  Several days later, and over two years since Moss Adams had received the subpoena, counsel for the trustee filed a motion seeking to hold Moss Adams in contempt.  In late October, just before a scheduled hearing concerning the contempt motion, Moss Adams produced hard copies of tax-related emails, as well as additional documents related to billing files.  One month later, Moss Adams produced nearly 600 pages of miscellaneous Microsoft Outlook documents, including appointments, emails, and spreadsheets.  

On three days in early December 2012, over 100 additional pages were produced to the trustee as the result of an exhaustive search spearheaded by the firm's general counsel.  At a hearing on December 7, 2012, the Court found that Moss Adams had failed to comply with the subpoena, and set an evidentiary hearing for February 14 2013 to examine the trustee's request for sanctions and a holding of contempt.  
On January 15, 2013, nearly 2.5 years after the original subpoena was issued and after thousands of documents had been produced in multiple productions, Moss Adams produced another 1,200 pages.  

Sanctions

After conducting an evidentiary hearing, the Court decided that it was appropriate to hold Moss Adams in contempt of court and order sanctions, noting that 

 Moss Adams and its counsel repeatedly assured the Trustee and his counsel that all documents responsive to the Subpoena, including both electronic and paper documents, had been produced, despite the fact that such assurances were incorrect. 

Judge Overstreet found that these shortcomings significantly hampered the trustee's ability to accurately ascertain the financial status of Berg's financial empire.  Additionally, Calvert cited the fact that Moss Adams utilized a document retention system that deleted emails after only several days, which, coupled with what Calvert has alleged was an inappropriate relationship with a Moss Adams employee that may have compromised the integrity of the audit work, could have yielded valuable and useful information.  As Judge Overstreet concluded,

Moss Adams’ failure to fully comply with the Subpoena hampered the Trustee both with regard to his duties to marshal the estates’ assets and his efforts to evaluate the estates’ claims against Moss Adams. 

Other Recent High-Profile Discovery Disputes in Ponzi Litigation

The dispute brings to mind the 'simply incredible' discovery errors cited by a Florida federal judge in a recent lawsuit against TD Bank for its culpability in the $1.4 billion Ponzi scheme perpetrated by Scott Rothstein.  There, TD Bank and its legal counsel, Greenberg Traurig, were sanctioned for the failure to turn over unfavorable evidence that could have led to an even more severe verdict than the $67 million award handed down by a Florida jury.  Attorneys later asked for more than $500,000 in subsequent legal fees incurred as a result of the sanctions.

A copy of Judge Overstreet's Order is here.
Sunday
Apr072013

California Man Pleads Guilty to $3 Million Ponzi Scheme; Could Be Released By End-Of-Year

Facing trial for thirty-eight counts of securities fraud, conspiracy, and grand theft, a California man agreed to plead guilty to running a $3 million Ponzi scheme that counted a former mayor as its victims.  Glenn Kane Jackson, 46, agreed to plead guilty to twenty-seven counts of securities fraud and grand theft just as jury selection was set to commence.  Jackson's wife, Gina McGee, had previously pled guilty and served a short stint in prison before being released.  Jackson was facing a maximum sentence of thirty years had he lost at trial, but with the plea deal, he could be free by the end of the year with credit for time served and good behavior.  

Jackson and his wife operated several entities under the Highlands Capital name, telling investors they could deliver lucrative returns through a foreign-currency trading operation that carried little risk.  Jackson befriended investors by describing himself as a former Navy Seal, and also relied on recruiting efforts by Kirk Hanson, a former mayor of Tiburon, California.  In total, the pair took in more than $4 million from investors.

However, Highlands Capital was not operating a profitable forex trading operation; to the contrary, Jackson racked up over $1.6 million in trading losses.  Investors were not told that the state of Wisconsin had ordered Jackson to cease-and-desist the sale of securities, or that Jackson had been fired from a previous job for misuse of company funds.  Nor was Jackson a former Navy Seal - rather, he had failed basic training and was involuntarily disenrolled.  Instead, the pair operated a Ponzi scheme, using new investor funds to pay returns to existing investors, in an attempt to show profitability. The couple also used investor funds to support a lavish lifestyle that included luxury travel, casinos, vehicles, clothing, jewelry, spas and dermatology treatments.  

More than $2 million remains unaccounted for.