It has been likened to the "holy grail" of the often difficult task assigned to court-appointed receivers or bankruptcy trustees tasked with recovering assets for victims of investment frauds: recovering 100% of victim losses when, in reality, recoveries typically average less than 10% of losses. Very few instances of 100% recoveries have occurred; indeed, the only occurrence in recent memory is that of Herbert Stettin, the court-appointed receiver for Scott Rothstein's $1.2 billion Ponzi scheme whose plan was heavily funded by a Canadian bank ensnared in Rothstein's scheme.
While Stettin's plan called for a 100% return to victims, he can no longer claim the distinction of the highest recovery. In an astounding announcement in a Ohio federal courtroom earlier this week, court-appointed receiver Mark Dottore announced that victims of David Dadante's $58 million Ponzi scheme will not only recover 100% of their losses, but will also receive at least an additional 10%. In response, U.S. District Judge Christopher Boyko questioned whether he was legally able to award a "success fee" to Dottore for the extraordinary outcome. After he was advised that a success fee would indeed be legal, Judge Boyko indicated he will make a decision at a future date.
Authorities arrested David Dadante in September 2007, charging him with operating a $50 million Ponzi scheme that advertised lucrative returns through supposedly low-risk trading strategies through his investment company. Investors were told that Dadante had a connection with a Goldman Sachs executive who provided him with exclusive access to initial public offerings - supposedly resulting in guaranteed annual returns ranging from 10% to 20%. In total, Dadante raised approximately $50 million from over 100 investors.
However, Dadante's exclusive Goldman Sachs connection was a complete fabrication. Instead, the promised above-average returns were possibly only by paying existing investors through incoming investor funds - the classic hallmark of a Ponzi scheme. After the Securities and Exchange Commission filed civil fraud charges against Dadante in 2006, criminal charges were filed in 2007. In December 2007, Dadante was sentenced to a 13-year prison term.
The Receivership and Recovery
Dottore, who is not a lawyer, embarked on a campaign spanning nearly a decade to recover funds for Dadante's victims. The cornerstone of this campaign was litigation filed against Ferris Baker Watts ("Ferris"), the former brokerage house where Dadante was a prominent client. There, Dadante enlisted the services of a broker to purchase and illegally manipulate the shares of Innotrac Corp., a lightly traded technology company. Even though Dadante's purchases raised eyebrows among Ferris employees, the brokerage ultimately extended him nearly $19 million to finance the trading. Dadante eventually accumulated several million shares of Innotrac - making him a 34% owner of the company.
The Ferris litigation ultimately concluded with a settlement that called for Ferris to pay $7.2 million in cash, as well as extinguish $9 million owed to the firm by Dadante. Additionally, Ferris also relinquished nearly 3 million shares of Innotrac. While the cash recovery and debt forgiveness were significant figures, the eventual sale of Innotrac shares resulted in a $38 million windfall to the receivership.
While Dadante took in approximately $50 million from investors, the fact that his scheme lasted for several years while paying out 10% to 20% interest resulted in a corresponding decrease in the net losses suffered by investors. In fact, after adjusting for interest payments to investors, Dottore estimated that the total losses due to Dadante's fraud were $28 million.
A "Success Fee?"
At Thursday's hearing, Dottore's lawyers disclosed that he had recovered $47 million in cash, and had also secured the forgiveness of $12 million in debts owed by Dadante. Additionally, an action remains pending against a commercial bank that could result in a further recovery for the receivership estate.
As a result of this recovery, Dottore informed Judge Boyko that Dadante's victims - who had waited nearly 8 years since the scheme was exposed - would not only recover their allowed loss, but would also be entitled to at least an additional 10%. Judge Boyko in turn directed Dottore's lawyer, Rob Glickman, to research whether the payment of a "success fee" to Dottore would be permitted in light of the unprecedented recovery. Glickman reported that he had researched the prospect of a bonus and believed that such a step would be permitted. Ultimately, Judge Boyko indicated he would take the matter under advisement.
Dottore's accomplishment is nothing shore of remarkable, and his efforts are to be applauded. One of the main takeaways from the recovery seen in Dadante's and Rothstein's situations is that the bulk of the recovered assets did not come through "traditional" sources such as the sale of personal or business assets or through the use of "clawback" lawsuits to recover profits from scheme "net winners." Indeed, it does not appear that clawback lawsuits even played a role in the recovery. Rather, the majority of the recovery was funded through the settlement with a deep-pocketed third-party. In Rothstein's case, the recovery was funded in large part by a settlement by TD Bank stemming from implications the bank and an employee actively participated in the scheme. In Dottore's case, the recovery came from the settlement with Ferris, which not only included a net recovery of $16 million due to the $7.2 million payment and $9 million debt forgiveness, but also the massive position in Innotrac shares. Dottore's decision (or good fortune) to delay liquidating the shares while they rose in value eventually resulted in a windfall to the receivership - and its victims.
While investors have signified their opposition to a "success fee" for Dottore, the simple question remains, what is Dottore required to do with the excess funds? With victim losses pegged at $28 million, it remains that, after distributions of 110%, there still would remain a surplus of approximately $15 million. One possibility is that, because Dottore is a receiver appointed by the Securities and Exchange Commission, the money could revert back to the treasury. This typically occurs in smaller receiverships when recoveries are not meaningful enough to justify the expense and time involved in a claims process. Another possibility is a larger payment to victims. This evokes a moral hazard angle, however, for victims truly would have profited from entrusting their funds to a Ponzi schemer. A ruling from Judge Boyko on a "success fee" is expected in the near future.
For more news and analysis of Ponzi schemes, visit Ponzitracker, a blog by Jordan Maglich, an attorney at Wiand Guerra King P.L.
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