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Litigation Journal

Fall 2022 | Work

A Receiver’s Colorful Journey into Fraudulent Schemes

Kathy Bazoian Phelps and Robert P. Mosier

Summary

  • The goal of the receivership is to marshal assets for the benefit of the defrauded victims.
  • The receiver must act quickly to preserve any available records and to recover assets.
  • Fraudsters often attempt to frustrate the receiver with hide-the-ball tactics.
A Receiver’s Colorful Journey into Fraudulent Schemes
Diy13 via Getty Images

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It is exciting to walk in the front door that first day. And sometimes scary. What could go wrong during regular business hours? Even though the U.S. Marshals and Federal Bureau of Investigation (FBI) warn that the owner could be armed and dangerous, the odds seem small that anyone would pull a gun on a group of professionals in business suits coming to take possession, right?

Federal equity receivers have the distinct privilege of taking over and shutting down businesses that regulatory agencies allege have violated federal or state laws. While regulators have already done some work to identify the violations, the reality is that little is known that first day upon takeover, and so the process of discovery begins. What violations were actually taking place? Where are the books and records, especially the electronic records? Where have the assets gone? Who is owed money? And so the receiver’s mission begins—to locate and preserve assets and to canvass claimant information to return funds to defrauded victims.

Preserving the Records

Fraudsters rarely provide a clear road map. Worse, fraudsters often attempt to frustrate the receiver with hide-the-ball tactics. The success of the receiver may be dependent on the nature of the scheme itself. If the scheme was originally a legitimate business that morphed into a Ponzi scheme, some real records might actually exist. However, if the scheme was a fraud from the inception, the receiver may not find complete, or any, records because there might never have been any legitimate operations.

Even though often flying blind, the receiver must act quickly to preserve any available records and to recover assets. The goal of the receivership is to marshal assets for the benefit of the defrauded victims of the perpetrator. To accomplish this goal, a receivership case moves through these phases: the invitation from the regulatory agency to serve as receiver, the first-day takedown, records preservation, discovering and marshaling assets, litigation, and finally claims administration and distribution. Each phase is full of discovery, coloring what the next phase will look like.

Receiver appointments are most frequently requested by federal regulatory agencies—the Securities and Exchange Commission, the Federal Trade Commission, the Commodities and Futures Trading Commission, the U.S. Department of Justice, or the Federal Housing Finance Agency. Enforcement actions are also brought by state agencies, including the states’ attorneys general, county district attorneys, or other state enforcement agencies that vary by state (for example, the Corporations Commission in California).

The phone rings. A representative from one of these agencies asks whether you are interested in possibly serving as a receiver, for example, in a sizable Ponzi scheme case. You certainly do not want to say no, so the discussion ensues about your interest, your experience, some basic facts about the case, and any possible conflicts of interest. From the regulator’s perspective, the objective is to identify a qualified and cost-effective candidate to take control of and, if necessary, to shut down the allegedly illegal operation.

The enforcement agency has already done the legwork and is therefore the potential receiver’s first source of good information about the allegedly illicit company. Gathering facts about the operations, the assets, and the nature of business is key to ensuring the receiver can competently handle the matter and will ultimately be paid in the case. This first conversation with the enforcement agency, however, is no guarantee that the gig will happen. The agencies typically interview and accept proposals from a few qualified candidates, which proposals are then forwarded to the regulatory agency’s selection committee. A winner emerges from the process and is recommended to the court for approval. Some courts defer to the agencies’ recommendations; others disregard the suggestion and rely on the judge’s own experience and judgment to select the receivers.

The invitation to serve is certainly no guarantee of an appointment, but it begins what might turn out to be a long, complicated, colorful, and rewarding process of providing some measure of restitution for the victims of a financial fraud.

The minute the order appointing the receiver is entered, the fun and the challenge begin.

Takeover, takedown, asset freeze, surprise attack—whatever you want to call it, that first day is often an exciting one. The receiver knows precious little before going in. How many people will be on the premises? Do they know the receiver is coming? What threats are lurking? What are the people hiding? The receiver may have to deal with locked doors, recalcitrant employees, the destruction of paper records, the removal of electronically stored information, tight lips, or worse.

Just prior to the takeover, the newly appointed receiver has only the knowledge that the regulatory investigators have shared and that can be gleaned from publicly available information. The regulators have probably obtained an asset freeze and the appointment of the receiver on an ex parte basis, under seal, so the fraudsters also have no idea what is about to happen.

The Takeover

Sometimes receivers can accomplish the takeover in the dark of night, minimizing conflict and simplifying the preservation of records and assets that are on-site. The receiver gains access after business hours and moves in with a computer forensic team that will image all computers on-site and look for links to cloud-based data. Any laptops or other devices containing electronically stored information left at the premises overnight are gifts. The receiver’s team will simultaneously focus on the hard-copy files to gain information about the operations, assets, bank accounts, and investors. Depending on the size of the operation and its sophistication, this initial exercise to secure the site can last all night.

All of that is just for one business site. If there are satellite offices or other locations in other cities or countries, the receiver needs to engage other professionals to plan a coordinated takeover. The seizure of the headquarters of the illicit operation after hours requires some stealth-like skills, not unlike an intruder’s efforts to disarm a security system to prevent notification that an outsider has just gained access.

A takedown after hours can also catch the fraudster off-guard. One receiver made arrangements with the FBI to coordinate a takedown at the business premises in the evening while the operator of the scheme was making a presentation to a group of new and unsuspecting investors at an off-site location. With members of the receiver’s staff present at the solicitation site, the FBI announced in the middle of the presentation that the company was ceasing operations and that a receiver had been appointed. Meanwhile, the receiver was on-site at the company’s headquarters with FBI agents standing by to gain access to the company’s headquarters to seize the books and records.

In other situations, a daytime intrusion is either necessary or desirable so that the receiver can meet face-to-face with the operators of the business to get a leg up on information while the people with the institutional knowledge are still present. The scene can go something like this: Just down the street, the receiver is meeting in the parking lot of the local Walmart or neighborhood store with the regulators, the U.S. Marshals, U.S. Postal Service inspectors, or local law enforcement if guns may be present. Also present are a forensic computer team to image computers on-site, the receiver’s proposed counsel and forensic accountant, a videographer to preserve the takedown, and enough staff people to be able to corral and contain the employees at the premises. With this army of professionals, the receiver is ready to take charge.

Holding multiple copies of the court order appointing the receiver, the receiver walks through the front door and announces the takeover. Step one is to immediately seek to stop the outflow of any communications from the owners and employees and the outflow of the people themselves and anything they might take with them as they run out the door. The goal, of course, is to be in control. But the balance, and the challenge, is to do so in a nonthreatening manner in the hope that civility and communication will lead to cooperation and a much more productive outcome. The perpetrators know where the gold is buried; the receiver’s goal is to get this information as agreeably as possible. The receiver meets with the owner; the receiver’s counsel invites all employees into the conference room and begins one-on-one interviews; the forensic accountant starts rummaging through the files and desk drawers; the computer forensic team starts imaging computers; the videographer captures each office, the personal property, and the files as they exist in those first moments. The place is crawling with the takeover, hopefully in a calm and controlled manner.

Piece by piece, the receiver will begin to understand the operations and acquire information through engagement with members of management and office workers. One-on-one meetings provide invaluable information about each person’s role and serve to help build an organizational chart. The story will begin to unfold, although not always in a straight line. Party A may say there are no operations in Arizona, but Party B said three new venues were opened in Arizona last year. One says there is absolutely no outside storage facility, and the other one hands you the key. The race is on to identify and locate assets and records before anything disappears.

All the while, the receiver is working hard to engender a spirit of cooperation in the quest to acquire information. On that first day, anything can happen. Once in a while, the receiver gets lucky, and an insider mole is dying to sing like a canary and tell the whole sordid tale of fraud on day one. Other times, a doe-eyed employee may ask politely to remove personal property from the company safe under the guise of “It’s mine but I was just storing it in the company safe”—but it just so happens to be a diamond-studded tiara purchased with stolen funds. Unfortunately, sometimes the owner may not be prepared to fold, and when he reaches for the gun under the desk, the receiver is thankful that the U.S. Marshals are present. One receiver can now laugh about the fact that the FBI had the foresight to remove the bullets from the defendant’s gun before the receiver walked in. That receiver, and another one who was the supposed target of two Colombian hitmen hired to take out the receiver after the hidden funds were located, both heeded the advice followed by most receivers—assume the worst, do not park your car where your license plate is visible, and do not share anything personal about yourself.

Caution, planning, professionalism, and a bit of paranoia go a long way in aiding the success of a first-day takeover, which hopefully gives the receiver a significant leg up in the information-gathering process.

As with the first-day takeover, the element of surprise is often necessary to prevent a fraudster’s records custodian from hiding relevant information. All documents should be seized because even a document that first appears to be immaterial or unimportant may later turn out to be the one document that reveals a secret account or hidden assets. Receivers may even check trash receptables for disregarded documents and retain scraps from the on-site shredder to aid in the identification of potential assets.

The records may all be there, in organized file cabinets and saved properly in QuickBooks or on Excel spreadsheets. Or the receiver may learn that all records are stored in the cloud, but no passwords are provided to access the information. Or sometimes the records that are provided are the cooked books and bear no relation to the reality of the fraud. Imagine the delight of the receiver who, after hours of interviews with the chief executive officer’s assistant, learns that the assistant has 25 compact discs (CDs) stored in her garage at the request of the CEO and that these are the actual, and not the cooked, records of the company. Or there may be no hard-copy files or electronically saved accounting records whatsoever.

In one case, the clerk of the court inadvertently gave notice to the perpetrator of an ex parte, under-seal application for appointment of a receiver, which was obviously not intended for the perpetrator’s eyes. By the time the receiver arrived at the business premises, the shredders were still warm, and the office had been completely cleaned of all paper but a single sticky note with a smiley face on it.

Where to Begin

In any of these scenarios, discovery of the truth is a process. Where to begin? Imaging the computers and servers is of paramount importance, even before the receiver’s team has accessed them—the last thing the receiver needs is the team’s fingerprints all over the records.

The goal is to grab hold of any business electronics that might easily walk out the door—cell phones used for business, flash drives, CDs, laptops, etc., and to obtain any and all passwords for devices and for cloud-based data. Having an experienced computer forensic team at the ready to assist in imaging and bypassing passwords is a must in most of these cases—unless luck prevails and the receiver locates all of the passwords on a sticky note inside the booze cabinet.

An analysis of deleted files and emails frequently bears fruit and should definitely be on the checklist. It is also important to consider that irate principals and investors may attempt to hack into the business’s computer system. Receivers should take special precautions to protect all data and to have the receiver’s office systems and firewalls checked and upgraded.

The order appointing a receiver can be a huge help in locating and preserving information, provided that the language in the order is clear and directive. Most people do not want to violate a court order that requires them to turn over information or passwords, so they will likely opt to turn over the information rather than run the risk of being held in contempt of court. With any luck and some planning, the order appointing the receiver will contain useful language requiring anyone who receives a copy of the order and who is in possession of documents, information, and passwords to turn them over to the receiver.

When the dust settles after the excitement and discovery of the first days, the often long and complex road to unraveling the scheme and reconstructing records begins. The process of locating and administering assets and of reconciling investor accounts can take months, if not years.

One key to the success of a receivership is the identification and seizure of assets for the purpose of returning value to the defrauded victims of a scheme. A receiver will obviously start with the low-hanging fruit. Liquid assets such as cash and securities are an obvious grab—if the receiver knows where those are located, that is.

A useful tool for federal receivers to extend jurisdiction and control over assets in other states is found in 28 U.S.C. § 754, which gives the receiver a right to take possession of assets in other districts upon filing the complaint in the regulatory action and the order appointing the receiver. That blessing comes with the burden of having to complete that filing within 10 days of the receiver’s appointment—often a challenging task if the receiver does not know that quickly where the assets are located.

Blanketing all local banks with notice of the receivership and asset freeze is a common practice born out of experience that the receivership defendants might not have disclosed all such accounts. Once accounts are located, remote access should be terminated, and all banking activity should be downloaded for close review of the cash flow and ultimate destination of the investors’ funds.

The opportunities for discovery of assets are limitless. Receivers must think like detectives. A receiver’s checklist might read as follows: Review FedEx, UPS, and other delivery service invoices from the business to determine whether there may be unauthorized asset transfers shipped directly from the offices. Research unclaimed property databases on the internet. Determine whether there are safety deposit boxes and take control of the contents. Locate any off-site storage facilities and secure them immediately. Review any prepaid accounts and deposits and pursue recovery. Print copies of documents stored in printers and fax machines and review all saved voicemail messages. Review credit card statements and tax returns. One receiver’s examination of expenses on credit card statements revealed so many significant travel expenses to Hawaii that this led to locating a condominium in Hawaii.

Publicly available searches and real property searches can also turn up real property assets or liens against business assets that might not have otherwise been disclosed. It may also be wise to run asset searches in other states where the defendants may have relatives, second homes, offices, or other businesses. Most receiver orders grant the receiver subpoena power, which can and should be used to seek information from third parties with possible information regarding the location or disposition of assets.

Sometimes it is just dumb luck that leads to asset recovery. One receiver found a sticky note on the floor with the phone number of a realtor, who then advised of a separate but related business in another state. Another receiver located a single sheet of paper in a hanging file that revealed a collectible $5 million note from the insider’s brother. And yet another one found thousands of Chinese New Year’s cards each stuffed with $5 bills. In another case, the death of a perpetrator detained in a French prison when he tried to flee the United States led to $30 million in life insurance proceeds.

Defrauded victims are often overpowered by the suspicion that the perpetrator hid their money overseas. While false conspiracy theories may abound, sometimes this is actually true. Receivers may find themselves working with foreign authorities or trying to persuade foreign financial institutions to obtain documentation or assets that worked their way overseas.

The receiver should not overlook the personal assets of the perpetrators of the fraud, which often reflect the trappings of the rich and famous: jewelry, furs, exotic cars, planes, boats, real estate, condos, and ancillary businesses (both domestic and foreign).

Litigation

Receivers are not necessarily in the business of filing litigation, but they also do not shy away if litigation is a path to additional recovery for the victims. Building a case, however, can be challenging for the receiver who has stepped into the shoes of the wrong-doing company and has precious little information. Interviews with principals, employees, investors, auditors, family members, bankers, and brokers may yield useful information. Subpoenas to banks, professionals, escrow companies, and any third parties believed to be in possession of relevant information are also critical tools to help a receiver build a case.

Litigation might be required for a variety of reasons, almost all of which are intended to enlarge the pot available for distribution to the claimants. Third parties who have allegedly engaged in wrongful conduct that caused some or all of the harm to the investors—particularly those with deep pockets—are common targets. Most commonly, these are the professionals and gatekeepers who surrounded the perpetrator and either knowingly or unwittingly participated in the scheme. Financial institutions, auditors, lawyers, and salespeople are common targets when they acted in a negligent or fraudulent manner. The insiders of the scheme are also, of course, common targets, although collecting from them is often problematic as they have had ample time to protect, conceal, or spend their stash.

One of the receiver’s greatest tools for recovery is fraudulent-transfer litigation, often referred to as clawback litigation. Investors who profited from the scheme may be targets. Or brokers who received sizable commissions for soliciting investors. Even nonprofit organizations can come under attack when they have received charitable contributions from the fraudster as part of the fraudster’s guise of trying to look good in the eyes of investors.

Litigation also serves a practical role in advancing a receivership case. Avoiding secured liens on personal or real property due to fraudulent conduct can free up substantial equity in remaining assets for defrauded victims. Or a recalcitrant defendant who refuses to turn over trust property overseas may have to contend with the court’s power of contempt. Receivers can sometimes force the production of documents or the turnover of assets that are required by a court order.

One other common area of litigation for receivers relates to insurance. Director and officer liability insurance can provide significant benefits depending on the policy and the types of claims made.

For any of these types of litigation, receivers will likely need to navigate around defenses asserted by defendants and insurance companies. Because litigation can be costly, which will eat into the amounts ultimately available to the victims, the prudent receiver will explore flexible fee arrangements with counsel. A contingency-fee arrangement preserves the upside while limiting the fee exposure for the estate if there is no ultimate recovery.

Victims’ Claims

The claims allowance and distribution phase of a receivership is where the rubber meets the road. It is all about getting a return to the claimants. The manner in which claims are allowed and how big of a piece of the pie the claimants receive is really what matters to them. The primary goal of the claims process, and really of the receivership itself, is to equitably provide returns for the investors. The receiver faces the difficult challenge of slicing a pie that is too small to feed a very hungry crowd of victims, each competing for the largest slice.

The first challenge is often how to calculate the amount of each victim’s claim. Receivers solicit information from the claimants by requiring them to submit a proof of claim form setting forth the amount of money they invested and any returns that were paid back to them. The ability to verify the claimants’ information may be dependent on the accuracy and completeness of the perpetrator’s records.

The calculation of the allowable amount of the investors’ claims can prove even more difficult, however. For example, Investor A invested early in the scheme and has not been paid anything back—he wants his principal back plus the interest that accrued over the years. Investor B also invested early and withdrew his interest monthly, so he has already received back 150 percent of the amount he invested, and he wants his principal back on top of that. Investor C put money in right before the receivership. How should each of their claims be calculated?

The goal is to arrive at a distribution scheme that is fair. But fair may not be the same thing as equal. Invariably, someone will feel shortchanged. The receiver has the tough job of proposing a distribution plan designed to be the most equitable based on the facts of a given case. Receivers have nicknamed one of the more common distribution methodologies used in receivership cases “rising tide.” This methodology requires the amount to be distributed to victims from a receivership to account for payments made to victims pre-receivership along with the proposed distribution to equalize the total percentage returns paid to investors. Investors often advocate for different types of plans, ranging from the last statement method, in which fictitious profits are allowed, to net investment, in which money returns pre-receivership are deducted from the principal amount invested to arrive at a claim amount. Making everyone happy with the distribution methodology is often impossible, but for the most part, these equitable proceedings reach a fair result based on the entirety of the picture that has been pieced together by the receiver. The receiver’s recommendations for equitable distribution carry a great deal of weight, but ultimately any distribution is subject to the approval of the supervising court.

The receiver’s job begins before the receiver is even appointed and is ongoing for the life of the case. As the story unfolds, the receiver’s role is to seek the truth, regardless of roadblocks, death threats, or stolen assets.

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