Bass, Berry & Sims attorney Chris Lazarini discussed a case involving the repercussions of the multi-billion dollar Ponzi scheme of Thomas Petters related to the management of the Stewardship Credit Arbitrage Fund, LLC (SCAF), which suffered significant losses after heavily investing in loans to entities controlled by Petters. The SEC sued Quan, manager of SCAF, but did not bring charges against SCAF. While waiting for appeal of the jury verdict against Quan, the district court froze SCAF's assets and a group of preferred investors in SCAF, claiming entitlement to a larger percentage of the distribution because they purchased less risky shares, moved to intervene, requesting immediate distribution of SCAF's assets. The Court of Appeals reviewed the district court's distribution plan for abuse of discretion, favoring pro rata distribution of assets since the funds of the defrauded victims were commingled and the victims were similarly situated as to the fraudsters.
Chris provided the analysis for Securities Litigation Commentator (SLC). The full text of the analysis is below and used with permission from the publication. If you would like to receive additional content from the SLC, please visit the SLC website to sign up for the newsletter.
SEC vs. Quan, No. 16-1072 (8th Cir., 8/30/17)
*A receiver's authority is defined by the order appointing him.
**A district court's power to supervise a receiver and determine the appropriateness of his actions is extremely broad.
***Courts favor pro rata distribution of assets where the funds of the defrauded victims were commingled and where the victims were similarly situated as to the fraudsters.
This appeal involves the repercussions of the multi-billion dollar Ponzi scheme of Thomas Petters. Defendant Quan managed the Stewardship Credit Arbitrage Fund, LLC ("SCAF"), which suffered significant losses after heavily investing in loans to entities controlled by Petters. The SEC sued Quan and two entities he controlled (but not SCAF) for securities fraud, alleging that Quan made false statements about what he did to protect against fraud and concealed problems with those entities' investments as Petters' scheme unraveled. The jury's verdict against Quan was upheld on appeal (SLA 2016-27). Meanwhile, SCAF received certain assets from the Petters' receivership in a court-approved settlement.
The district court froze SCAF's assets, some $18 million, and appointed a receiver to manage SCAF. The SEC then moved to amend its complaint to make SCAF a defendant in the Quan case. A group of preferred investors in SCAF, claiming entitlement to a larger percentage of the distribution because they purchased less risky shares ("Appellants"), moved to intervene, requesting immediate distribution of SCAF's assets. The district court granted the SEC's motion to amend and Appellants' motion to intervene, but denied the motion for immediate distribution.
Acting to protect SCAF's assets from the costs of defending against the SEC's claims, the receiver and the SEC proposed a stipulation that, after resolution of the claims against Quan, SCAF and the SEC would apply the judgment to the claims against SCAF. Over Appellants' objection, the court approved the stipulation.
While Quan's appeal of the adverse jury verdict was pending, the receiver and the SEC proposed a second stipulation in which SCAF conceded that it had violated the securities laws, consented to entry of judgment against it and agreed that its assets would be disgorged. Over Appellants' objection, the court approved the second stipulation. Finally, over Appellants' objection, the court approved the receiver's and SEC’s proposed distribution plan which would pay 40% of SCAF's assets to its secured creditors and the remaining 60% to SCAF's investors without regard to their class. This appeal followed.
The Court of Appeals reviews the district court's oversight of the receiver and approval of the stipulations and distribution plan for abuse of discretion. It finds no error in the approval of the first and second stipulations, concluding that it was well within the court's broad discretionary power to approve stipulations preventing the unnecessary dissipation of receivership assets in defending against the SEC's claims. The Court finds the receiver's and the district court's determination of overlap between Quan's and SCAF's actions appropriate and their decision to allow the receiver to benefit from resolution of the claims against Quan without precluding the receiver's ability to raise future defenses sound. Similarly, there was no error in the approval of the distribution plan. Explaining why courts "routinely endorse" pro rata distributions as the most fair and equitable approach in fraud cases, the Court states that the investor classes were fraudulently induced into investing in SCAF by the same misrepresentations, putting them in a similar situation with respect to the fraud and the fraudsters. This equitable distribution, the Court states, is favored over one that effectively allows the fraudsters to control unwinding their fraud by using whatever arbitrary allocations they created.