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Recent SEC Releases
Monday
Sep022013

Alleged Ponzi Schemer Dies; $10+ Million Still Owed to Victims

A former Sunday school teacher who allegedly used his tax preparation service to dupe victims in a $10 million Ponzi scheme has passed away - just months after a court-appointed bankruptcy trustee warned victims that a 3% - 4% recovery was likely.  Jack Brown, owner of Soddy Daisy-based Brown's Tax Service ("BTS") and frequent preacher/Sunday school teacher at the Sale Creek Church of God, saw his business forced into involuntary bankruptcy in late 2012 amid mounting concerns from clients who had invested over $10 million with him.  While Brown had initially refused to cooperate, recent reports suggested that he had been cooperating with bankruptcy trustee Jerry Farinash.

Using his relationship with clients of BTS, as well as his connections through his Sunday School teaching position, Brown began promising annual returns of up to 15% that were purportedly attainable as a result of his God-given gift as a successful stock day trader.  The investments were memorialized through promissory notes, and while the first promissory note was issued in 1989, the pace quickened in 2003.  By 2012, Brown and BTS had raised more than $10 million from investors.

However, mounting concerns began to materialize in late 2012 about the solvency of Brown's operation.  These concerns were confirmed when a local attorney filed a petition to have BTS placed in bankruptcy, alleging that Brown had been operating a Ponzi scheme that had just collapsed.  Rather than using investor funds to day-trade as promised, Brown was accused of misappropriating millions of dollars to purchase lakefront property that was lavishly outfitted with an indoor gymnasium, a golf simulator, a full bar, various games, several vintage automobiles, and even the authentic floor from the Boston Garden sports arena.  In bankruptcy filings, Brown claimed only $1.4 million in assets while representing a yearly income of less than $30,000.  

After the appointment of a bankruptcy trustee, Brown initially refused efforts to cooperate, citing his failing health.  According to the trustee, Brown "refused to answer questions which would not be protected under the Fifth Amendment" while also claiming that his health has deteriorated to the point where he is movable only by ambulance.   This lack of cooperation soon changed in March 2013, when Brown, appearing at a creditor's meeting telephonically from his hospital bed, confessed to operating the scheme.  However, Brown maintained through his attorney that there was no money to return, because all the victims had not only been paid back, but some had profited handsomely from the scheme - hinting that the victims knew they were not paying taxes on their gains.  

In the months following Brown's confession, the bankruptcy trustee accused Brown's son of participating in the scheme in what was called a "family Ponzi scheme."  Additionally, Brown's wife has since invoked her Fifth Amendment right against self-incrimination numerous times.  

Thursday
Aug292013

Court Denies Investment Fund's Ponzi Loss Claim Based on Sophistication

Many red flags were waving in 2008. As set forth in detail in the Receiver’s response, there were many indicia that would lead a sophisticated institutional investor to question the prudence of investing in Valhalla. Not only had Nadel been disbarred from the practice of law in New York for dishonesty and fraud, but many judgments were outstanding against him in Sarasota County, Florida, along with divorce proceedings that alleged his defrauding of numerous individuals. With respect to Valhalla, a person disclosed in the private placement memorandum was Michael Zucker, the subject of a cease and desist order. Based on the record in these proceedings, there is no doubt that institutional investors like the Genium entities were placed on inquiry notice and cannot show good faith. 

[Editor's Note: In the interests of full disclosure, the author currently is part of the legal team representing the Receiver in this case and was involved in the instant proceedings.]

In what is believed to be a first in Ponzi scheme jurisprudence, an investment fund that purportedly lost over $1 million in a massive Ponzi scheme has been prohibited from participating in the ensuing claims process based in part on its sophistication and failure to spot "red flags."  In a decision Thursday afternoon, a federal district judge in the Middle District of Florida ruled that the submission of an incomplete proof of claim, as well as the failure to spot the "many red flags" surrounding the investment, could serve as the basis for denying the claim of a Swiss investment entity.  The decision could potentially have widespread ramifications in the niche area of Ponzi scheme litigation, especially in schemes involving a large amount of institutional investors.

The claim was originally submitted during the court-approved claims process stemming from the $330 million Ponzi scheme perpetrated by Arthur Nadel.  While a timely claim was submitted, the claim form was filled out by a Swiss bank that failed to disclose the beneficial (or legal) owner of the investment.  While the Receiver later asked the claimant to submit this information, this request was explicitly refused.  This information was important in evaluating the claim, for it was possible that the claimant (i) could have had multiple accounts; (ii) could have received other funds or transfers from the scheme not specifically tied to their investment, such as commissions; and (iii) could have been an insider or co-conspirator.  When attempts to obtain the information failed, the Receiver recommended denial of the claim, which was later affirmed by the court.

After the court approved the initial denial of the claim, an unrelated investment fund "purchased" the underlying claim, which has been known to occur in larger Ponzi schemes.  The purchasing entity continued to maintain that the claim was timely, and disputed that the original claimant was a sophisticated investment professional.  The Court ruled otherwise, finding that the investment fund was not similarly situated to the hundreds of innocent victims.  

The ruling is important for several reasons.  First, it may mark the first time that a "net loser" instititutional investor had a claim for their losses denied based on their sophistication.  Importantly, there was no "smoking gun," such as an incriminating email or letter; rather, simple due diligence such as a public records search would have shown that the fraudster had been disbarred for fraud, had several money judgments against him, and had previously filed an affidavit claiming he was indigent. An increased adoption of this standard could spur institutional investors to change their due diligence procedures when selecting an investment - especially when those investment procedures previously involved simply choosing funds with high returns.  Second, the ruling confirms that an investor's good faith may be considered in the claims process, and an investor may not blindly make an investment when numerous "red flags" should have put them on notice of the possible illegitimacy of the scheme. Going forward, the decision is likely to be cited for the proposition that institutional investors and non-sophisticated investors are not necessarily "similarly-situated" claimants.

The entire decision is available here:

Claim Order by jmaglich1

Wednesday
Aug282013

TD Bank Sued In New South Florida Ponzi Scheme

A south Florida attorney who disappeared before being arrested on federal bank fraud charges has been accused of perpetrating a million-dollar Ponzi scheme in a recently-filed lawsuit that also includes TD Bank, N.A. as a defendant.  Timothy McCabe, 55, disappeared in early April after being accused of unethical behavior by the Florida Bar, and authorities later discovered that several million dollars was missing from his law firm's trust account.  While McCabe sent cryptic messages alluding to committing suicide, he later returned to face criminal charges.  Now, a recently-filed lawsuit accuses McCabe of misappropriating funds to support a $1.2 million Ponzi scheme.  Also named in the lawsuit is TD Bank, which has already paid out hundreds of millions of dollars since being implicated in another south Florida Ponzi scheme - the infamous $1.4 billion Ponzi scheme perpetrated by disgraced Florida attorney Scott Rothstein. 

McCabe was a partner at Lake Worth law firm McCabe and Samiljan LLC ("M&S"), which advertised itself as a real estate and foreclosure defense law firm.  M&S also served as a title agent for Old Republic Title Insurance Company ("Old Republic"), assisting in the issuance of title insurance policies and serving as a closing agent in real estate transactions.  McCabe was also a managing member of City Title, LLC ("City Title").  

The lawsuit alleges McCabe used his position as principal of City Title and as a signatory on the M&S Escrow Trust account to commingle incoming funds, which often included the deposit of checks in the M&S Trust Account held at TD Bank that were directed to City Title.  McCabe is also alleged to have diverted hundreds of thousands of dollars intended for the satisfaction of client mortgages for unauthorized purposes, including the sustenance of an "investment club" McCabe operated that is alleged to have been nothing more than a Ponzi scheme.  

The complaint asserts Racketeer Influenced and Corrupt Organization ("RICO") charges against McCabe and numerous other defendants, including McCabe's law partner, Old Republic, and M&S.  The Complaint also accuses TD Bank of failing to exercise proper supervision over the M&S Trust Account by allowing McCabe to improperly deposit checks into the account that were made payable to other parties.  TD Bank has been embroiled in numerous lawsuits relating to its role in Scott Rothstein's $1.4 billion Ponzi scheme, which has resulted in hundreds of millions of dollars in settlements and one jury verdict.  

A copy of the lawsuit is here.

Wednesday
Aug282013

Guilty Plea in $300 Million New Zealand Ponzi Scheme

A New Zealand man called New Zealand's "Madoff" has pleaded guilty to masterminding a massive Ponzi scheme that took in nearly $300 million from investors and is believed to be the country's largest Ponzi scheme.  David Ross, 63, appeared in court today to plead guilty to five charges of false accounting and theft.  Ross, who was previously hospitalized in November for treatment under New Zealand's Mental Health Act, had been free on bail with a court-imposed allowance of $1,000 per week.  

Ross was the director of Ross Asset Management ("RAM"), which he used along with numerous associated entities to solicit investors with the promise of guaranteed and lucrative returns - including annual returns of up to nearly 40%.  Investors received regular returns, and Ross was generally perceived as an astute investor.  However, in late 2012, many investors began complaining about delays in scheduled payments, and in November 2012, authorities from New Zealand's Financial Markets Authority raided RAM's offices.

After a Receiver was appointed to sort out RAM's finances, a preliminary investigation showed that while RAM reported investments of nearly $450 million to nearly 1,000 investors, only $10 million remained in RAM's accounts.  The Receiver, John Fisk, estimated that RAM took in over $300 million since 2000, keeping nearly $30 million kept as management fees while $290 million was withdrawn or paid to investors.  Fisk also found that the fund was insolvent since 2007 - that is, fund outflows exceeded new investor inflows, sometimes by $60 million.  When authorities raised RAM's offices in November, the scheme was on the verge of collapse.

Ross will remain jailed until his sentencing in October. Each false accounting charges carries a maximum sentence of ten years, while the fraud charge carries a maximum seven-year term.

Tuesday
Aug272013

Madoff Trustee Reaches $98 Million Settlement With Feeder Fund

The trustee tasked with recovering funds for victims of Bernard Madoff's $65 billion Ponzi scheme announced he had reached a settlement with a Connecticut hedge fund that acted as a "feeder fund" in shoveling millions of dollars into Madoff's scheme.  Irving Picard, the court-appointed trustee, recently sought court approval for a settlement with Maxam Absolute Return Fund ("Maxam") that called for the return of nearly $98 million in funds that had been withdrawn from Madoff's scheme just before its collapse.  In return, an allowed claim of over $276 million will be recognized on behalf of Maxam, which will be permitted to share in future distributions to investors.  The settlement brings the total amount of funds recovered by Picard to nearly $9.5 billion - with total allowed claims to date of just over $11 billion.

Picard sued Maxam in December 2010, as well as its founder, Sandra Manzke, and several of her family members.  In the lawsuit, Picard alleged that Maxam and its principals disregarded well-known red flags surrounding Madoff's brokerage to take advantage of the steady and constant returns offered.  Indeed, despite the detailed procedure set forth in Maxam's due diligence questionnaires, S. Manzke later testified that no due diligence was performed - rather, the investment was simply a continuation of an earlier investment made while she served as CEO of Tremont Capital Managment ("Tremont").  Maxam invested nearly $300 million into Madoff's scheme, and in the two years preceding Madoff's fraud, withdrew a total of over $97 million.

Under the terms of the settlement with Picard, Maxam will return the nearly $98 million it withdrew in the two years preceding the bankruptcy filing by Madoff's brokerage firm.  In return, Picard will drop all litigation against Maxam and the individual parties, and will recognize an allowed claim on behalf of Maxam in the amount of $276,687,000.00 (the "Allowed Claim").  Based on the amount of funds recovered by Picard since his appointment, it is likely that Maxam will recover a significant portion of that amount. 

Under federal bankruptcy laws, a bankruptcy trustee may recover transfers received by a defendant within two years of the bankruptcy petition date under 11 U.S.C. § 548(a)(1)(A).  Once actual fraud is established (which is satisfied by the finding that the perpetrator operated a Ponzi scheme), a defendant must then demonstrate that he/she both received the transfers in good faith and provided value.  See 11 U.S.C. § 548(c).  Here, while it is typically understood that an investor gives "value" when receiving redemptions of their principal investment (that is, the amount of their withdrawals has not yet eclipsed the total principal amount of their investment), the dispute likely centered on whether Maxam had taken the withdrawals in good faith. Indeed, Picard's complaint is rife with allegations that Maxam disregarded, ignored, and flouted their purported due diligence procedures in an attempt to show that obvious red flags were ignored in the pursuit of above-average profits from Madoff's scheme.  Relevant caselaw has required that a transferee must demonstrate the undertaking of a diligent investigation, and a simple inquiry with the schemer is not sufficient.  Thus, the decision to settle likely took into account the evidence that Maxam had not properly conducted due diligence.

Coincidentally, S. Manzke formed Maxam in 2005 after leaving her previous position as CEO of Tremont Capital Management ("Tremont"), which later reached a $1 billion settlement with Picard over its Madoff exposure.

A copy of the Settlement Motion is here.