The Securities and Exchange Commission filed an enforcement action against the operator of a large-scale Ponzi scheme. The hedge fund operator pleaded guilty to a multi-count indictment for securities fraud, wire fraud, mail fraud and other charges. The SEC appointed a receiver who sued numerous hedge fund investors seeking to claw back false profits under the theories of avoidance of fraudulent transfers under the state’s uniform fraudulent transfer act and unjust enrichment, scamming customers in a ripoff attempt to earn back profits.
Question(s) For Expert Witness
- 1. At what point were the hedge funds and managers insolvent?
- 2. Was the investment club at issue ever involved in a Ponzi scheme?
Expert Witness Response
Even using the numbers provided by the receiver that we feel are incorrect, the data shows that the hedge funds’ actual trading performance from inception to 2005 was a positive of nearly $23 million, net of trading losses incurred to that date.
Further, it appears that the receiver assumed that all distributions made were from profits. In fact, people who withdraw from a hedge fund receive a return of capital that is not part of a profit distribution. These different classifications of amounts distributed should be factored out when determining if distributions made were in excess of income.
When all of the funds in question are totaled for profitable years from 2002 through 2005, there were trading profits of more than $40 million. When losses are included for the years that had losses, we calculated net investment trading profits in excess of $38 million. The receiver acknowledges net profits of more than $28 million for the same period. So, while our numbers may differ from the receiver, we agree that during the years in question (2000-2005) the hedge funds at issue earned a significant net profit on trades.
Woefully insufficient evidence exists to support the claim that to a reasonable certainty the hedge funds operated in 1999 to 2004 were Ponzi schemes. We conclude without fear of contradiction that based on the evidence we have received to date, the manager appears to have operated a substantial underlying investment business during this period.
The evidence supports a position that the entities were not a Ponzi scheme from the beginning but went through a fundamental change at some point.
With specific reference to the investment club, it appears that considerable information is missing, as well as at least one brokerage account, as related to over $2.8 million of gains. It is my opinion that the investment club fund did not use new investor monies to pay past investors, as distributions were from earnings and profits and a return of capital when the additional transactions and profits are included in the analysis.
The expert is a certified public accountant with more than 20 years of experience.