SEC Unveils System Designed to Catch the Next Madoff

In an excellent feature, Reuters details the extensive steps taken by the SEC to reform a system facing overwhelming criticism in light of the failure to detect Bernard Madoff's massive Ponzi scheme.  While still in their infancy, critics see the changes as a much-needed step in the right direction.  Even Harry Markopolos, the financial analyst who famously faulted the SEC for repeatedly rebuffing his warnings that Madoff was running a Ponzi scheme, lauded the moves, saying that the "they [the SEC] have done a fabulous job of reforming themselves. 

The reforms deal mainly with the way the SEC handles tips and complaints from its constituents.  Under the SEC's prior system, tips in the form of phone calls, emails, faxes, and even handwritten letters were received at the SEC's eleven regional offices and Washington office.  Yet, upon receipt, the complaints were not made accessible to other regional offices; instead, they were filed away and inaccessible to other offices.  Thus, a regional office receiving a complaint had no way of knowing whether any other regional office had received similar complaints without placing a call to potentially every regional office.  

Enter the Tips, Complaints and Referrals database.  Known to insiders as TCR, the database was officially deployed for inter-agency use in March 2011 and brings a previously-unavailable ability to automate access to complaints.  Aided in part by a first-ever partnership with the Federal Bureau of Investigation, 2,300 SEC employees are now able to view and add information once a tip or complaint is added to the system.  

The presence of the FBI also seeks to minimize the disconnect between civil and criminal investigations.  Under a deal reached between the two agencies, the FBI is now permitted access to tips involving securities fraud, which enable the criminal aspect of a case to begin at an earlier stage than usual.  Both agencies are quick to note that the enhanced collaboration takes place before an official investigation commences to avoid the appearance of improper collaboration or information sharing.  

Another visible reform is the agency's newly-formed Market Intelligence Unit, headed by 19-year SEC veteran Thomas Sporkin.  In Washington, the MIU's forty-one employees analyze over 100 tips, complaints and referrals that come in each day, prioritizing the legitimate referrals and striving to route these referrals for follow-up. Additionally, in light of recent rules adopted by the SEC, individuals such as Markopolos now have expanded incentives to submit such tips.  Under a rule adopted in May spurred by Dodd-Frank, a whistleblower who submits significant evidence of financial fraud that yields SEC sanctions of at least $1 million is now eligible for a financial award.  The terms of such an award are much broader than before Dodd-Frank was passed, when an award was limited to insider-trading cases and could not exceed ten percent of penalties collected.  

Markopolos, who has since submitted three tips to the MIU, has received follow-up calls from SEC attorneys within days, if not hours, of his submission.  According to him, "[e]verything they should have done in the Madoff case they are now doing."

Guilty Plea in Florida Real Estate Investment Ponzi Scheme

A Boynton Beach man who once hosted a television talk show discussing real estate investment pled guilty to a count of mail fraud in connection with a Ponzi scheme he ran for several years in Palm Beach, Florida.  Anthony Cutaia, 65, had recently been indicted on nine counts of mail fraud, each of which carry a maximum prison sentence of twenty years.  In the plea agreement with Cutaia, prosecutors have agreed to recommend that any sentence imposed be at the lower end of the range provided by the probation office, provided Cutaia make full disclosure regarding his crimes and not withhold any facts.  

From 2002 to 2006, Cutaia was the host of a regular Sunday morning television program entitled "Talk About Mortgages and Real Estate."  Cutaia also hosted a radio talk program and hosted seminars throughout the Palm Beach area, in which he solicited investors for CMG Property Investment Group, which he incorporated in late 2002.  Cutaia, through CMG, sold investments in "Contract Participation Agreements" to investors which purported to be commercial real estate investments, specifically for the purchase and sale of various commercial real estate properties.  Per the terms of these "investments", investors would share in profits and receive regular interest payments during the life of the investment.  Instead, only a portion of investor funds were used for their intended purpose, and the majority of funds were used to pay personal expenses and to make payments to investors purporting to be interest payments from what Cutaia heralded as successful and profitable ventures.  According to the plea agreement, Cutaia ultimately collected and misappropriated over $1 million of investor funds.

A sentencing date for Mr. Cutaia has not yet been set.  Mail fraud carries a maximum sentence of twenty years, although the setnencing recommendation from the U.S. Probation Office is likely to be much less.  Under the Mandatory Victim Restitution Act and Victim and Witness Protection Act of 1982, the Court may also order restitution to victims of Cutaia's fraud, along with a fine of up to $250,000.

Judge Rejects Plea Agreement in Utah Ponzi Scheme

In a somewhat-unusual step, a Utah federal judge refused to accept a plea agreement reached between Utah prosecutors and a man accused of operating the second-largest Ponzi scheme in Utah history.  Travis Wright, 48,of Draper, Utah, had earlier pled guilty to one count of mail fraud, under which prosecutors had agreed to seek an eight-year sentence along with an order of restitution to defrauded investors.  However, after reviewing letters from victims who expressed their outrage at the sentence they perceived as inadequate, United States District Judge Clark Waddoups decided that that he would not approve the deal.  His decision means that Wright is free to withdraw his guilty plea and proceed to trial, or negotiate a different plea agreement with prosecutors that would meet the Judge's approval.  Judge Waddoups' comments indicate that an acceptable plea deal will carry a sentence longer than the proposed eight years.

From September 1999 to March 2009, Wright was a manager at Waterford Funding, which purported to use investor funds to make loans secured by commercial real estate investments.  In total, Waterford took in $145 million from 175 investors who were promised returns of up to forty-four percent over nine-month periods. But Wright ultimately used less than 10% of investor funds to make loans through Waterford.  The remaining funds were misappropriated to fund Wright's lavish lifestyle, including the purchase of a $5.5 million home, safari trips to Africa, and an inflated salary.  Additionally, new investor contributions were paid to older investors as interest payments.  Prosecutors have estimated that victim losses could reach in excess of $50 million.  

Prosecutors must now decide whether to negotiate a new sentence with Wright or proceed to trial.  Wright pled guilty to mail fraud, which carries a maximum prison sentence of twenty years and up to a $250,000 fine.

A copy of a previously filed SEC Injunctive Action is here.

UniCredit Defendants Seek Dismissal of Madoff Trustee's $60 Billion Lawsuit

Bank Austria and several other named defendants (the "Bank Austria Defendants") have filed a motion to dismiss Irving Picard's racketeering lawsuit, joining several other high-profile banking entities in recent weeks who have sought to blunt the aggressive campaign by Picard to recover funds for victims of Bernard Madoff's massive Ponzi scheme.  In several motions filed Monday and Tuesday, the Bank Austria Defendants asked United States District Judge Jed S. Rakoff, who earlier agreed that the lawsuit belonged in federal court rather than bankruptcy court, to dismiss the suits based on the Racketeer Influenced and Corrupt Organizations Act ("RICO"), arguing that Picard's application of RICO is too far-reaching to pass legal muster.

Picard, the court-appointed trustee overseeing the liquidation of Bernard Madoff's now-defunct brokerage, had filed suit against the Bank Austria Defendants in December 2010, seeking damages of $19.6 billion based on Picard's then-estimate of total principal losses by Madoff investors.  Additionally, a successful plaintiff in a RICO suit is entitled to treble damages, which brought the potential total award amount to nearly $60 billion.  

Picard alleges that Sonia Kohn, who controlled Bank Medici, had a relationship with Madoff starting in 1985 in which she steered millions of dollars in investor funds to Madoff's brokerage in return for fees.  Yet, as the Bank Austria Defendants allege, the relationships which form the basis of Picard's claims did not occur until the restructuring of one of the defendant's investments with Madoff following the 2007 acquisition of Bank Austria.  

The Bank Austria Defendants also cite to the recent opinion in MLSMK Investment Co. v. JP Morgan Chase & Co., covered here by Ponzitracker, in which the Second Circuit held that RICO claims brought by a Madoff investor against JP Morgan were barred by the Private Securities Litigation Reform Act ("PSLRA") and thus subject to dismissal.  The Bank Austria Defendants urge Judge Rakoff to adopt this logic, stating, 

"Conduct undertaken to keep a securities fraud Ponzi scheme alive is conduct undertaken in connection with the purchase and sale of securities and is barred by the RICO amendment.  This alone should end the RICO claims in this case."

(internal quotations omitted).  

Finally, the Bank Austria Defendants also raise the issue of the extraterritorial application of Picard's RICO allegations.  The United States Supreme Court recently decided Morrison v. National Australia Bank Ltd. and set forth a test to determine whether Congress intended a statute to have extraterritorial, rather than purely domestic, reach.  Morrison has come to represent a growing inclination of US Courts to abstain from giving extraterritorial reach to a statute without clear Congressional intent.  Moreover, the Second Circuit's recent decision in Norex Petroleum Ltd. v. Access Industries, Inc. interpreted RICO in light of Morrison's newly-espoused test and also concluded that RICO claims could only be enforced domestically.  In light of the feeder funds' status as foreign entities, argue the Bank Austria Defendants, the RICO statute has no extraterritorial reach and thus the claims should be dismissed.

Under federal rules of civil procedure, Picard now has twenty-one days to respond to the motion.

A copy of the original complaint against the Bank Austria Defendants is here.

A copy of the Pioneer Defendant's Motion to Dismiss is here.

A copy of Bank Austria's Motion to Dismiss is here.

Jury Convicts Colorado Man for $30 Million Ponzi Scheme

A Denver federal jury found a Colorado man guilty of thirty-one counts, including money laundering, mail fraud, conspiracy, and conspiracy, stemming from a nearly-decade long Ponzi scheme that cost investors nearly $30 million.  Philip Lochmiller Sr., of Grand Junction, Colorado, faces a prison sentence of up to 415 years if he receives the maximum sentence under each charge.

Lochmiller Sr. operated Valley Investments along with his step-son, Philip Lochmiller Jr. and assistant Shawnee Carver.  Both Lochmiller Jr. and Carver previously entered into guilty pleas which required them to provide testimony against Lochmiller Sr.  Beginning in 1999, Valley Investments acquired several parcels of land to develop affordable housing communities.  Newspaper advertisements solicited potential investors to finance the acquisition, promising annual returns of ten to eighteen percent in return.  Investors were given promissory notes that were purportedly secured by lots of land in the communities.  Instead, investor funds were used to pay expenses, personal bills, and provide interest to older investors.  The scheme came to an end in 2008 when the three were indicted.

While sentencing has not been scheduled, Lochmiller Sr. is due back in Court on October 27 to address the amount of restitution he may be ordered to pay to defrauded investors.  A court-appointed attorney tasked with overseeing Valley Investment assets has previously estimated that victims could expect to recover 3%-5% of their original investment.