Case Studies

Receivership

Registered Investment Advisor–Federal Indictment for Fraud

This Receivership was initiated in June 2010 as the result of fraudulent operations by a Registered Investment Advisor (“RIA”) who managed and invested approximately $100 million in funds deposited from 80 clients and investors over a period of 10+ years. The Receivership is still in process and has involved:

  • The management and extensive legal work around 7 individual receiverships Forensic tracing of thousands of cash transactions and transfers between Special Purpose Investment Entities (“SPIE”), investors, operating companies and vendors
  • Forensic tracing, shutting down and liquidating operating companies
  • Negotiating settlements with vendors
  • Reviewing and processing dozens of investor claims
  • Investigating D & O insurance policies and third party malpractice claims
  • Selling intellectual property for $10 million to Google
  • Performing Board Observer roles
  • Selling a company for $54 million to a NASDAQ listed public company and subsequent assignment of responsibility as the Shareholder Representative of an $8 million escrow holdback
  • Working closely in cooperation and negotiating as necessary with several government agencies- DOJ, SEC, FBI, and IRS and overall maximizing net asset recoveries for the ultimate distribution of cash and well being for 80 investors who, in many cases, had their retirement and life savings at risk of total loss

The Receiver determined that the net cash invested (total cash invested less total cash received by investors over 10+ years) was $60 million.  To date, the Receiver has been successful in achieving asset recoveries of $30 million in cash while spending less than 5% in total Receivership expenses.  One of the very complex challenges has been how these recovered funds should be distributed to the 80 investors that were invested in the various connected SPIEs with cross-loans, liquidation preferences, different classes of stock, clawbacks, etc.

The Receiver developed various distribution models for consideration based upon several criteria and compared the distribution amounts that each investor would receive under each model.  The range of outcomes varied greatly.  Under normal circumstances in determining the payouts from business liquidations, one would follow the flow of legal documents supporting preferences rights. If done so in this case, some investors would have received two times their net cash invested while many other investors would have had a 100% loss. However, according to the FBI criminal indictment, fraud had permeated all of the RIA’s organization of SPIEs and therefore it was determined that some investors should not benefit at the expense of other investors.  Rather, all investors should be treated the same and the $30 million in recoveries should be put in one bucket-ignoring whatever SPIE an investor may have invested in originally and ignoring all legal contracts that may have been in existence on preference rights.  Thus every investor would get $.50 for each $1 dollar of net cash invested.

The Receiver filed this distribution method in a motion with the Court and it was approved by the Court and by the SEC and DOJ, who had the right with the indictment to seize the $30 million in cash proceeds parked in the Receiver’s bank accounts if there was not agreement by all parties.  This process also subsequently required negotiating and settling all investor objections to this “one-bucket” distribution approach. Ultimately, when the Receivership is completed all investors will get approximately half their money back, which is considered to be a very successful outcome in such cases, according to the DOJ.

Background

This Receivership filed in Washington State Superior Court was an extremely complex case in involving a Registered Investment Advisor that set-up numerous interconnected LLCs as Special Purpose Investment Entities to manage and invest approximately $100 million in funds deposited from 80 clients and investors in a period that covered over 10 years.  These SPIE’s were formed with cash redemption rights, much like mutual funds.  However, the RIA, was fraudulent in not disclosing and informing the investors (according to a Federal Criminal Indictment by the FBI and an SEC lawsuit), that the investor’s funds were invested into several very high risk startup and early stage non-profitable companies. In addition, in several of these operating companies the RIA installed himself in very strong and controlling positions on their Board of Directors.  The RIA charged his investor’s management fees for managing their money as well as receiving forms of compensation from the companies in which he invested his investors funds. This double compensation was also not fully disclosed to his investors.

Ultimately, one of the operating companies (which had never achieved any revenue in 10 years of existence and was burning a significant amount of cash), had to cease operations and close its doors.  At that point the RIA (who was Chairman of the Board) had over $38 million of his investor’s money invested in the company but could not keep it funded.  When the RIA’s investors were notified of this company’s demise, many investors demanded their investments returned by exercising their redemption rights. Since all the funds being managed by the RIA were in illiquid venture type investments, there was insufficient liquidity to pay the redemptions, forcing the RIA to put the SPIE’s as well as the one operating company mentioned above into bankruptcy, or in this case a Receivership.