Appeals Court Rules Madoff Trustee Can't Pursue Banks for $30 Billion in Claims

"No doubt, there are advantages to the course Picard wants to follow. But equity has its limits." 

A federal appeals court dealt a significant setback to the quest to recover funds for victims of Bernard Madoff's $65 billion Ponzi scheme, ruling that the court-appointed bankruptcy trustee could not pursue claims totaling more than $30 billion against financial institutions accused of aiding the scheme.  The U.S. Court of Appeals for the Second Circuit issued a unanimous order Thursday upholding the dismissal of claims that JP Morgan, HSBC, Unicredit, and UBS (the "Financial Institutions") 'aided and abetted' Madoff's fraud by ignoring numerous red flags that should have alerted them to the fraud.  The three-judge panel agreed that, under the theory of in pari delicto, because the bankruptcy trustee, Irving Picard, stood in the shoes of Madoff's former firm, he was precluded from bringing claims against third parties for their role in a fraud that Madoff's firm masterminded.  

Picard filed lawsuits against a multitude of financial institutions in 2009 and 2010, including the Financial Institutions.  Originally filed in bankruptcy court, the Financial Institutions sought to have the actions removed to federal district court based on Picard's standing to assert the claims, as well as whether the claims were precluded by the Securities Litigation Uniform Standards Act.  In late 2011, two different federal judges in the Southern District of New York granted motions to dismiss the trustee's common-law claims against the Financial Institutions, finding that Picard's claims were barred by the doctrine of in pari delicto.  Picard immediately appealed those decisions.

The doctrine of in pari delicto, translating to 'in equal fault,' is a compelling defense in the realm of bankruptcy jurisprudence, as "a debtor’s misconduct is imputed to the trustee because, innocent as he may be, he acts as the debtor’s representative." The Wagoner rule, drawn from the seminal case of Shearson Lehman Hutton, Inc. v. Wagoner, bars a trustee from suing to recover for a wrong that he himself essentially took part in. 944 F.2d 114, 118 (2d Cir. 1991).  Under this authority, the Second Circuit reasoned that

Picard alleges that the Defendants were complicit in Madoff’s fraud and facilitated his Ponzi scheme by providing (well-paid) financial services while ignoring obvious warning signs. These claims fall squarely within the rule of Wagoner and the ensuing cases: Picard stands in the shoes of BLMIS and may not assert claims against third parties for participating in a fraud that BLMIS orchestrated.

Dismissing Picard's claims that the doctrine did not apply or, in the event that it did, he was exempted as a trustee under the Securities Investor Protection Act, chief Judge Dennis Jacobs remarked that "Picard's scattershot responses are resourceful, but they all miss the mark."  

While Picard appealed to principles of equity in contending he should be permitted to bring the claims, the Court questioned the merits of this approach, remarking "it is not obvious why customers cannot bring their own suits against the Defendants."  As the Financial Institutions pointed out, indeed some victims have already done so.

While Picard still holds bankruptcy claims against the Financial Institutions totaling more than $4 billion, the Second Circuit's decision is a significant setback in the quest to recover funds for Madoff's victims, who to date have received three distributions of approximately 43% of approved losses.  To date, Picard has approved approximately $11 billion in claims, while he has recovered approximately $9.3 billion.

A copy of the Court's decision is here.

Arrests in Alleged $4 Billion Japanese Cow-Raising Ponzi Scheme

A former cattle farm manager and two other executives were arrested by Japanese authorities on Tuesday after they were accused of misleading participants in an investment venture that promised steady returns from a "wagyu beef ownership system."  Former president Kumiko Mikajiri, 69, and former managing senior directors Susumu Masubuchi, 59, and Katsuya Oishi, 74, were charged with soliciting investors based on misleading information relating to the actual number of breeding cows.  The company, Agura Bokujo, filed for bankruptcy in August 2011 with stated debts of approximately ¥420 billion - equating to approximately $4.2 billion - and ranks as the largest episode of consumer fraud in Japan's history.

Agura Bokujo was established in 1981, and was once Japan's second-largest beef producer.  Several decades ago, the company began offering a "wagyu beef ownership system" in which investors could purchase "wagyu" cows with an initial investment ranging from $35,000 to $58,000 per cow.  The cows would then be used for breeding, which would then yield proceeds from the sale of their calves.  Investors were promised steady returns of up to 8% annually, as well as the promise that Agura Bokujo would buy the cow back at the end of a period of several years.  Wagyu cows are a delicacy due to their enhanced diet, and their steaks can cost over several hundreds of dollars per pound.  Tens of thousands of investors took advantage of the program, no doubt drawn in by the promise of steady returns.  Agura Bokujo represented in business reports that it had 90,000 to 100,000 breeding cows on hand.

However, the massive earthquake that struck Tokyo in March 2011 wreaked havoc on the company, with fears that radiation from a Tokyo nuclear power plant had entered Japan's food chain.  These fears were well-founded after it was discovered that cattle had consumed severely-contaminated hay.  The discovery led to numerous requests by investors to cancel their contracts, and combined with a sharp decrease in demand for beef over radioactivity fears, the company was forced to file for bankruptcy protection in August 2011.  At the time of the bankruptcy, the company had approximately 71,000 investors in its cattle breeding program.  In a rehabilitation plan, the company proposed that it would buy back cattle for 10% of their principal value - a nearly total loss for investors.

After an investigation by Japanese authorities, it was discovered that company principals may have inflated the amount of cattle it purportedly owned.  According to authorities, approximately 100 investors received brochures containing incorrect information just before the company filed for bankruptcy.  Rather than a herd of 90,000 to 100,000 cows, authorities believe the amount of cows were closer to 60,000.  Thus, because the number of investors outnumbered the actual number of cows, it would appear that the same cow was sold multiple times to investors.  

According to a bankruptcy administrator, of the approximately $4.2 billion owed to investors, Agura Bokujo can currently repay only approximately $200 million.

Guilty Plea in $600 Million Prepaid-Funeral Ponzi Scheme

A St. Louis woman has pled guilty to her role in a massive Ponzi scheme that billed itself as a nationwide leader in the sale of prearranged funerals.  Sharon Nekol Province, 69, of Baldwin, Missouri, entered into a plea agreement with prosecutors in advance of a pending August trial date, pleading guilty to six federal charges, including wire fraud, mail fraud, and misappropriation of human premiums.  Province is scheduled to be sentenced on November 7, 2013, before United States District Judge Jean Hamilton, and prosecutors have agreed to recommend a maximum sentence of three years in prison, with the possibility that Province could avoid prison time through a sentence of probation.  

According to authorities, National Prearranged Services ("NPS") was created in 1979 and based in Clayton, Missouri.  Beginning in 1992, and through the use of its two subsidiaries, Lincoln Memorial Life Insurance ("LMIS") and Memorial Service Life Insurance ("MSLI"), it employed an aggressive sales strategy extolling the idea of pre-paying for funeral costs and playing on fears that family members could be footed with the bill.  Potential investors were told that the 'funeral contract' was essentially was an insurance policy ensuring that most, if not all, funeral costs would be taken care of upon an investor's death.  After agreeing on the amount of the policy, which often ranged from $5,000 to $10,000, investors were given the option to pay the entire policy in full or through periodic installments.  To ensure the safety of investor funds, NPS represented that it would deposit the majority of funds with a third-party trustee, often a financial institution, that would hold the funds until they were needed for funeral services. From 1992 to 2008, about 150,000 people purchased prearranged funeral policies through NPS.

However, many of these representations were untrue.  For example, the majority of investor funds were not deposited with neutral third-parties as promised, but instead were retained by NPS.  Additionally, NPS borrowed large amounts of the cash surrender value of the insurance policies taken out by investors, which in turn reduced the amount of death benefits that would be available to policy holders.  Funds were also used from new purchasers to pay policy premiums on the lives of previous purchasers, as well as for reimbursal of funeral services for earlier purchasers.

In 2008, authorities unsealed a 50-count indictment against six individuals that served as officers, directors, or advisers of NPS, including Province and several members of the Cassity family.  Province, who started as an administrative secretary, had risen to serve as secretary of NPS and vice-president of LMIS.  Her attorneys portrayed her as much less culpable than her co-defendants, who enjoyed immense wealth from their role in the scheme.  For example, James Cassity, who had previously served time for conspiracy and tax fraud violations, purchased several expensive homes - including a Nantucket home he sold to Google co-founder Eric Schmidt for $16 million in 2005.  Cassity, who is described by some as the "Bernard Madoff of Missouri," has maintained his innocence.  

A trial is scheduled for early August for the remaining defendants.  

Six Years Later, Boy Band Founder's Ponzi Scheme Victims Set For 4% Payout

Photo: AP Photo/ John RaouxMore than six years after his $300 million Ponzi scheme collapsed, victims of former boy band mogul Lou Pearlman's scheme are set to receive an initial payout of just four cents on the dollar.  In a distribution plan (the "Plan") filed by the bankruptcy trustee appointed to recover funds for Pearlman's victims, an investor with an allowed claim of $100,000 would be entitled to $4,000, with the chance that future distributions could eventually add to this total.  Pearlman, who was arrested in June 2007 after fleeing to Indonesia, and is currently serving a 25-year prison sentence in an Eastern Texas prison.  He is currently scheduled to be released on March 24, 2029.

The Scheme

Pearlman operated a vast array of businesses from airlines to blimp companies to entertainment ventures.  While some of his businesses were legitimate enterprises, he used these profitable businesses to sustain other unprofitable businesses, including TransContinental Airlines ("TCA"). Investors were solicited to invest in TCA, drawn by the promise of above-market interest rates as well as the future possibility of an initial public offering (IPO) that would result in exponential returns for initial investors.  Pearlman also offered investments through TCA in an alleged "Employee Investment Savings Account," which was apparently designed to mimic the Employee Retirement Investment Savings Account (ERISA) established under federal law.  In total, investors contributed nearly $300 million to Pearlman's various ventures.

In addition to his legitimate ventures, Pearlman also used the massive cash horde generated by his creation of two wildly-popular boy bands, 'N Sync and the Backstreet Boys.  While under contract, the groups essentially financed Pearlman's other unprofitable ventures through a stead stream of cash.  However, after the groups successfully sued to escape their contract, Pearlman was faced with mounting investor obligations while cash inflows decreased.  As a last ditch effort, Pearlman even established his own fake accounting firm, Cohen & Siegel ("C&S"), which existed solely to forward phones and generate bogus accounting reports and audits. After an unsuccessful attempt to quickly liquidate assets to support the failing scheme, Pearlman fled to Thailand in 2007.  After he was spotted by a tourist, he was arrested, extradited back to the United States, and pled guilty in February 2008.

The Plan

The bankruptcy trustee, Soneet Kapila, was appointed in early 2007 and was tasked with unraveling Pearlman's fraud and marshaling funds for defrauded investors.  Discovering that little cash was left from Pearlman's businesses, the trustee filed over 700 'clawback' lawsuits targeting investors who had received distributions in excess of their principal investment.  Notably, one of these clawback lawsuits was profiled on Discovery Channel's True Crime with Aphrodite Jones, in which the investor sued by Kapila hired a hitman to kill him in order to allow his family to collect on a generous life insurance policy.  The hired killer was later caught and sentenced to twenty years in prison.

Of the 700-plus clawback cases, Kapila and his team have recovered more than $30 million, and litigation remains ongoing.  However, administrative fees due to Kapila and other professionals have reduced the amount of cash on hand to approximately $14 million.  

The Plan proposes that, after paying administrative and priority claims totaling approximately $4 million, investors holding nearly $260 million in unsecured claims will be entitled to a distribution amounting to 4% of their approved claim.  Because those investors will receive less than the full amount of their claim, federal bankruptcy laws entitle them to submit ballots voting for or against the Plan.  The committee representing unsecured creditors has urged approval of the Plan, warning that drawn-out litigation threatens to eliminate any recovery.

A confirmation hearing on the Plan will be held on July 17, 2013 at 2:30 p.m.  

A copy of the Distribution Plan is here.

New Zealand's 'Madoff' Charged With Country's Largest Ponzi Scheme

A New Zealand fund manager was charged with masterminding a $320 million Ponzi scheme which, if true, would rank as the largest Ponzi scheme in New Zealand's history.  David Ross, 63, was charged with four counts of false accounting and one theft charge relating to his investment firm, Ross Asset Management, which drew scrutiny last year after payments were delayed to investors.  Each false accounting charges carries a maximum sentence of ten years, while the fraud charge carries a maximum seven-year term.

According to authorities, Ross Asset Management ("RAM") and numerous associates entities solicited investors with the promise of guaranteed and lucrative returns - including returns of nearly 40% in some years.  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.  A Receiver was appointed to sort out RAM's finances, and a preliminary report issued shortly after his appointment showed that RAM had roughly $10 million of investments - approximately 2% of the $449 million reported to investors.  

The Receiver, John Fisk, identified investments of nearly $450 million held on behalf of more than 900 investors holding 1720 individual accounts.  Since 2000, Fisk estimated, RAM took in over $300 million, keeping nearly $30 million kept as management fees while $290 million was withdrawn or paid to investors.  Additionally, since 2007, fund outflows have exceeded incoming funds - the lifeblood of a Ponzi scheme - by at least $60 million.  

Ross was hospitalized in November for treatment under New Zealand's Mental Health Act, and remains free on bail with a court-imposed allowance of $1,000 per week.