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.