Court Takes Control of Funds Tied to Petters

(CN) - A federal judge stripped control of a hedge fund to protect investors and prevent diversion of settlement money intended for victims of the Thomas Petters Ponzi scam.

Petters is serving 50 years for running a $3.65 billion Ponzi scheme in which he claimed to sell electronics to big box retailers such as Wal-Mart and Costco.

In March 2011 the Securities and Exchange Commission obtained an asset freeze of companies owned by Marlon Quan that had allegedly funneled $459 million into the Petters scam, and extracted $90 million in fees.

Quan had a "glaring conflict of interest" with his investors and could not be relied upon to act in their interest, according to the SEC. As evidence of those priorities, the SEC said Quan concealed losses from investors with a series of sham "round-trip" transactions, giving Petters money that he recycled to Quan funds.

Those investors were victims of securities fraud and have an interest in disgorgement of Quan's ill-gotten gains, which mush be considered equitably against the interests of creditors, according to the SEC.

Two of those creditors, DZ Bank, the fourth largest German bank, and Sovereign Bank, a Spanish-owned U.S. bank, opposed the SEC's motion to appoint a receiver over Quan's company, Stewardship Credit Arbitrage Fund.

The banks characterize the fund's assets as investment recoveries, "not obtained as the result of the SEC's proof or settlement of its security fraud allegations," according to the court.

Rather than equitable distribution, the banks want the court to prioritize fund distribution for creditors over equity holders. The SEC objected to distribution under such terms because the banks would receive two-thirds of the frozen funds despite holding only 8 percent of outstanding claims.

Instead of deciding on the principle used to distribute the funds, U.S. District Judge Ann Montgomery focused on preventing potential harm to all the claimants and on ensuring maximal recover of the fund's assets.

"There is a strong likelihood that a receiver will do more good than harm," she wrote Monday. "Not only will a receiver prevent the harm that would result if funds are distributed before a receiver has clarified SCAF's finances, a receiver will also ensure that SCAF's assets have been fully identified and collected by a neutral fiduciary."

Montgomery noted, however, that equitable distribution may be necessary because the merits of the SEC's case against Quan had not been resolved.

If Quan is convicted of securities fraud, disgorgement of the frozen funds might be required as the ill-gotten gains of his crime.

"Because the potential for disgorgement exists, the funds will not be distributed at this time," Montgomery wrote.

DZ Bank and Quan objected that appointment of a receiver would be redundant and expensive because recovery of SCAF assets is mostly complete.

Montgomery disagreed, noting that the parties overseeing the recovery efforts were "DZ Bank, who was acting in its own self interest," and "Quan, who is accused of defrauding investors."

To limit the costs of the receivership, Montgomery imposed an injunction staying any litigation against SCAF while the receiver does its work. The stay also preserves the Minnesota federal court's jurisdiction over eventual distribution of SCAF assets and the settlement funds.

Montgomery appointed Gary Hansen of Oppenheimer, Wolff & Donnelly as receiver of SCAF and two other Quan-controlled entities.

Quan, who remains in control of Acorn Capital Management and Stewardship Investment Advisors, continues to face charges in Judge Montgomery's court that he facilitated the Petters fraud and falsely assured investors that their money was safeguarded in lockbox accounts.

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