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.

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.  

Investors Sue "SEC APPROVED" Ponzi Schemers And County Bank For $5.1 Million

A group of investors that lost millions of dollars in what authorities alleged was a $60 million Ponzi scheme filed a lawsuit against the alleged Ponzi schemers and the community bank listed on their marketing materials as a reference. The lawsuit named Santa Cruz County Bank (the "Bank") as a co-defendant, along with John A. Geringer, Christopher Luck and Keith Rode, who operated the GLR Growth Fund.  The lawsuit asserted claims of conspiracy and violations of federal securities laws against all defendants, as well as claims of aiding and abetting fraud, aiding and abetting breach of fiduciary duty, and negligent misrepresentations against the Bank. 

Geringer, Luck and Rode formed the GLR Growth Fund, L.P. (the "Fund") in 2003.  Geringer, who managed the Fund's trading accounts and made investing decisions, told potential investors that the Fund consistently achieved annual returns ranging from 17% to 25%, including a return of 24% in 2008 (when the S&P 500 lost 38.5%.).  In marketing materials distributed to investors, the Fund purported to invest 75% of its assets in publicly traded securities, options, and commodities.  Investors were also told that the Fund used the services of an independent accountant, and account statements regularly included the caption "MEMBER NASD AND SEC APPROVED".  Based on these representations, the Fund raised at least $60 million from hundreds of investors.  

However, the Fund did not consistently earn double-digit returns, but in reality experienced trading losses every year from 2005 to 2009, including a 33% loss in 2008 and a 92% decline in 2009.  Additionally, rather than invest in publicly traded securities, the Fund instead invested nearly $30 million, or half of the total funds raised from investors, in two private startup technology companies that were highly illiquid.  By mid-2009, the Fund had stopped trading entirely after suffering massive losses. With no trading returns to pay to investors, Geringer instead used funds contributed by existing investors to create the false appearance of profitability - a classic hallmark of a Ponzi scheme.  The SEC filed a civil enforcement action in May 2012, and Geringer, Luck, and Rode were indicted in December 2012.  

According to the lawsuit, the Fund's marketing materials listed the Bank and Chuck Maffia - then a vice-president at the Bank - as a "Banking Reference".  Investors that contacted Maffia were told that the Fund was a safe, conservative investment option, with Maffia disclosing that his own retirement funds were invested in the Fund.  Additionally,

Maffia emphasized that the Fund’s clients had never sustained any losses; Geringer was an excellent investment manager; and the Bank handled and oversaw all the funds in the Fund Account.  Finally, Maffia told Mr. Elliot that Maffia would not have invested his own retirement money in the Fund but for the confidence both the Bank and he had in Geringer. 

Some investors also allegedly were provided with tax returns and other documents that supposedly verified the Fund's consistent returns.  As the Complaint makes clear, investors were assured by Maffia's statements regarding the safety and legitimacy of the Fund, and would not have invested absent these assurances.

While asserting claims against financial institutions for their role in facilitating Ponzi schemes has been historically difficult due to the high standard of proof required to show liability, the case evokes multiple similarities to the circumstances surrounding TD Bank's role in the massive Ponzi scheme by Florida lawyer Scott Rothstein.  There, TD Bank was ultimately forced to pay out hundreds of millions of dollars in settlements and adverse verdicts from investors who alleged that Rothstein was assisted by a TD Bank vice-president who lent the scheme an aura of legitimacy.

A copy of the complaint is below.

2013-03-21 Geringer_Complaint

SEC Files Suit Against Profitable Sunrise, Calls It "Fraud and Pyramid Scheme"

The Securities and Exchange Commission ("SEC") charged a British company doing business as Profitable Sunrise with multiple violations of federal securities law, alleging it was a fraud and pyramid scheme that took in tens of millions of dollars from tens of thousands of investors.  The complaint, filed in federal court in the Northern District of Georgia, was accompanied by an emergency request for (and subsequent order granting) an asset freeze to preserve investor funds in the interim.  The SEC named Inter Reef Ltd., which does business as Profitable Sunrise, as the sole defendant, and also named several entities as relief defendants which received funds from individuals wishing to invest in Profitable Sunrise.  The SEC is seeking injunctive relief, an order freezing bank accounts in the Czech Republic and Hungary, an order requiring accounting of funds received from investors, and civil monetary penalties.

Beginning no later than December 2012, Profitable Sunrise offered investors the opportunity to profit "with every sunrise" by promising astronomical returns to investors.  The company heavily emphasized its religious ties, including multiple Bible quotes on its website and claiming to donate a large portion of its profits to charity.   Investors were told that they could receive daily returns ranging from 1.6% to 2.7% as a result of Profitable Sunrise's lucrative business making loans to other businesses at high rates.  The company represented that an investment had very little risk, as each loan was insured against default.  

Investors were given the option to choose one of five investment plans:

1. The Starter Plan;
2. The Regular Plan;
3. The Advanced Plan;
4. The Private Plan; and 
5. The Long Haul Plan.

The first three plans required minimum investments of $10, $500, and $2,500, respectively, and promised daily interest rates of 1.6%, 1.8%, and 2%, respectively.  Each of those plans carried a term of 180 business days, with balances compounding daily.  The fourth plan, the Private Plan, was available only to groups.  The last plan, the Long Haul Plan, had a 240-day duration, and promised a daily 2.7% interest rate with a minimum $500 investment.  

Once an individual became an investor, he or she was then allowed to recruit additional investors with the understanding that they would be entitled to 5% of all investments, and subsequent earnings, they brought in.  This resulted in an onslaught of solicitations, which only assisted in spreading the word about Profitable Sunrise.  As one video on Youtube noted, a $5,000 investment would yield nearly $186,000 in less than six months - a return of nearly 4,000%.  

However, according to the SEC, Profitable Sunrise did not make lucrative loans with other businesses, nor did it insure its loans with a leading investment bank.  Rather, it operated a massive fraudulent fraud and pyramid scheme, using the promise of astronomical returns and referral incentives to take in what is likely to be tens or even hundreds of millions of dollars from investors.  Indeed, the SEC alleges that at least one promoter claims to have raised tens of millions of dollars from investors. The SEC estimates that tens of thousands of investors were likely duped in the scheme.

The SEC named several Czech Republic companies as relief defendants, which were used to collect money from investors.  These companies are Melland Company S.R.O., Solutions Company S.R.O., Color Shock S.R.O., and Fortuna K.S.R.O.  According to the SEC, millions of dollars in investor funds flowed between these companies.

The move comes as multiple states, including South Dakota, Nevada, Missouri, and North Carolina,   have recently moved for cease-and-desit orders against Profitable Sunrise.

A hearing on the SEC's preliminary injunction is scheduled for April 15, 2013.

A copy of the Complaint is here.

h/t to ASDUpdates.

Former Political Candidate Who Promised 'Real Change' Indicted in Concert Promotion Ponzi Scheme

“The people of Hawaii need to learn that there is no such thing as an investment with guaranteed returns of 25 percent to 50 percent.  Somehow these cases keep recurring here. It’s baffling."

-FBI Special Agent Tom Simon

A Hawaii man who once ran for political office was indicted on charges that his concert and promotion business was a Ponzi scheme that took in over $1 million from at least 29 Hawaii families.  Jason Pascua, a U.S. Army Reservist and former candidate for the Hawaii House of Representatives, was charged with a single count of wire fraud, which carries a maximum prison sentence of twenty years in prison as well as criminal monetary penalties.  According to authorities, Pascua is not currently in Hawaii and has not been arrested, with news reports suggesting that he will plead guilty upon his return on May 23, 2013.  

Pascua was the sole owner of J2 Marketing Solutions ("J2"), which purported to be in the concert and nightclub promotions industry.  A regular on the political circuit, Pascua frequently mingled with Hawaii politicians and even tried his hand at running for political office in 2010.  Pascua also had extensive community ties, having previously served as President of the local Filipino Chamber of Commerce and a marketing director of the Hawaii Central Credit Union.  

Beginning in 2009, Pascua used these ties to solicit investors to invest in J2, telling them he worked as a concert and nightclub promoter spliting his time between Honolulu and Las Vegas.  Investors were offered the opportunity to earn short-term returns of 25%-50% by financing Pascua's promotion of multiple concert and night club events.  Pascua assured investors he would spread their investments over the promotion of multiple events in an effort to "mitigate risk."  Ultimately, Pascua would raise more than $1 million from nearly 30 Hawaii families. 

However, according to authorities, Pascua did not use investor funds to promote concerts or night club events.  Rather, he diverted funds for his own personal use, as well as pay fictitious returns to investors.  Ironically, Pascua did use some funds for event promotion - but those events were pet expos at a popular Hawaii entertainment complex.