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Gordon v. Dadante

United States District Court, N.D. Ohio, Eastern Division

July 24, 2018




         There has never been a case like this one in all the years and in all the cases over which this Court has presided. It started off like so many other tragic cases involving innocent investors being bilked out of millions of dollars by a trusted, yet unscrupulous advisor promising substantial guaranteed returns on investments. Yet, in actuality, the advisor used the investor funds for his own personal aggrandizement. The investors sued, the United States Attorney investigated, the advisor was arrested, convicted and incarcerated and, upon the request of the investors, a Receiver was appointed. There followed almost a decade of intense litigation, contentious hearings, investors pitted against investors, some siding with the Receiver, some seeking his removal. But during all of this a most extraordinary thing occurred. An investment the advisor made actually returned a substantial return. In what appears to the Court to be the first of its kind, the investors have received not only all the monies they invested in the Ponzi scheme but have received substantial monies above and beyond their initial investments. All due largely to the extraordinary achievements of the Receiver that many of them now seek to vilify.

         As a result of this singularly remarkable and unheard of accomplishment, the Receivership has distributed to each defrauded investor 110% of their initial investments with substantial funds remaining in the Receivership estate. What to do with these remaining funds now weighs on the Court. In light of this extraordinary recovery, the Court has considered whether to award the Receiver additional compensation for his efforts in achieving the remarkable result in the face of bitter feuding and fighting with many of the investors in whose interest he was acting. When the Court indicated to the parties its intent to award additional compensation, the blow back was strong and intense with accusations leveled against the Court itself. In light of the response, the Court decided to step back and refer the matter to a Magistrate Judge for a Report and Recommendation to obtain a fresh perspective from a valued colleague with no history on the case. The Magistrate Judge produced, in the opinion of the Court, an extraordinarily detailed, thorough and well-reasoned recommendation that the Receiver be given additional fees in light of his efforts and achievements in the context of comparable fees of the market in general. It is against this recommendation that the investors and Receiver's counsel object and which the Court now addresses.

         The Court became involved in the case nearly seven years after its inception, well after the appointment of the Receiver and the method and amount of his compensation had been determined along with the establishment of his reporting and fee application protocols. On April 24, 2014, the Court held a hearing on Receiver's Request to Distribute Funds to IPOF Fund Investors in Excess of 100% of Investment, to Approve Settlement with Wells Fargo Advisors, LLC, the Response to Court's Inquiry About Fee Issues (Doc. # 576), along with the Amended Supplement thereto (Doc. # 583). In his Request to Distribute, the Receiver asked the Court for “a reasonable additional fee in this matter based on the extraordinary work of the Receiver that has resulted in an unprecedented result for the benefit of the IPOF Fund limited partners.” (ECF # 576 pg 7159). As part of the hearing, the Court heard objections from the parties and investor representatives on awarding additional compensation to the Receiver.

         After hearing arguments for and objections against, and after considering the limited law in this area, the Court, in an Order issued June 20, 2014, found it had the equitable authority to adjust the Receiver's compensation. The Court ordered the Receiver to file an updated report by an independent auditing firm on comparable hourly rates, which the Receiver provided. Thereafter followed several additional rounds of briefing and ultimately resulted in referral to the Magistrate Judge.

         In his Report and Recommendation, the Magistrate Judge determined that after consideration of the appropriate factors, the Receiver should be given additional compensation in the amount of $1, 203, 175 and that a total of $106, 608.50 be deducted from the Receiver's Fee Application.

         Facts Pertinent to the Issues Remaining in the Case

         The history of the case is lengthy due largely to its age and the contentiousness that permeated it from its inception. The Court will not recount the background as the Magistrate Judge's Report and Recommendation tells the story with complete accuracy and in great detail. The Court recounts only those facts from the history of the case it finds pertinent to the Objections of the parties and the ruling of the Court.

         Prior to 2005, David Dadante solicited over $50 million dollars from investors to form Investment Funds: IPOF, L.P., IPOF Fund, GSI and IPOF Fund II, L.P. Dadante encouraged investors to invest with him because he was working with a major Wall Street firm and was obtaining a return rate of 25% per year. He also represented that his funds were secure.

         In November 2005, the initial Complaint in this action was filed, alleging that Dadante's investment scheme was actually a Ponzi scheme intended to swindle investors. In furtherance of his scheme Dadante made material representations about the nature of the investments, made false account statements and manipulated accounts. The Complaint alleged federal and state securities violations as well as RICO and common law fraud claims. Along with the Complaint, Plaintiffs asked for the Court to appoint a Receiver and proposed Mark Dottore as Receiver.

         At the time of his appointment, the Receiver's hourly rate was $195 per hour. The Receiver went about identifying and marshaling the assets of the Receivership, which included 4.3 million shares of Innotrac Corp. stock purchased by Dadante comprising over 34 % of the Innotrac outstanding common stock. As of 2009, the stock price fluctuated between $2 and $4 per share.

         However, the stock was substantially encumbered by millions of dollars of margin debt used to purchase much of the stock. With brokerage firms threatening to call in the margin debt and force a sale of the stock, the Receiver sought an order from the Court prohibiting the brokerage firms from liquidating Innotrac stock and calling in the margin debt. The Court also gave the Receiver the authority to direct the sale of the stock.

         Thereafter, the Receiver implemented several strategies to maximize the investors' recovery. These included obtaining tax refunds for investors who paid taxes on the illusory benefits of the Fund based on the fraudulent statements provided by Dadante. Using tax professionals to prepare corrected returns, the Receiver successfully argued for investors to receive five years worth of corrected tax return relief as opposed to the statutory limitation period of three years. He obtained an $8.5 million settlement with Dadante. He obtained margin debt forgiveness of between $9 and $12 million and settled with the brokerage firms. He resisted the efforts of investors and the Innotrac board to sell the shares prematurely, particularly right after the great economic recession of 2008 when stock prices dropped precipitously. Instead, he held onto the shares until he sold them in 2013 for a sale price of $8.20 a share for a total sale value of $35, 438, 522.

         All these efforts did not come without a cost. Dating to 2006, the investors became divided over how the litigation should proceed and how to distribute the assets of the Receivership. Those investors who opposed the Receiver's actions moved to terminate the Receivership in 2007 based largely on the expense of the Receiver. The Court denied the Motion but ordered an accounting of his fees and expenses which the Receiver provided.

         Shortly thereafter, these same investors, known informally as the “Regalbuto Group, ” sought to liquidate the Receivership assets, arguing in part that the Innoctrac stock lacked any real value. A liquidation at that time would have resulted in a loss to all investors of most of their initial investments. All of this opposition further cost the Receivership needless monies.

         Against the backdrop of continuing objections to the Receiver by the opposing investors, the Court brought in an independent auditing firm the Analysis Research Planning Corp. (“ARPC”) (also referred to as the “Kennedy Report”) to review the billing and fees charged by the Receiver. That audit found the Receiver and his professionals were not billing at unreasonable rates, but instead were well below the upper end of management fees charged for comparable work.

         After the sale of Innotrac stock the Receiver moved to distribute to the investors $26, 960, 280 of the Receivership assets on top of the approximately $5.1 million previously distributed. The Court granted the disbursement, allowing the Receiver to retain nearly $5 million in assets for further litigation fees, with the intent of a final distribution at the close of all related litigation.

         Magistrate Judge's Report and Recommendation on Additional Compensation and Fees

         Because the Court had already determined it had the discretion to award additional compensation to the Receiver, the Magistrate Judge confined his Report and Recommendation to determining a reasonable amount. In his Report and Recommendation, the Magistrate Judge, in reliance on applicable caselaw and prior rulings of the Court, recommended using the lodestar method in determining the reasonable compensation of the Receiver. As discussed by the Magistrate Judge, the lodestar method calculates a reasonable fee using hours worked multiplied by a reasonable hourly rate. The Receiver has already received over $3.5 million in fees during the course of the litigation. However, the Magistrate Judge recognized that the investors had received, as a direct result of the work of the Receiver, 110% of their initial investments. Such an unusual recovery in a criminal Ponzi scheme is unprecedented and as such, there is no analogous caselaw. In reaching his recommended additional compensation amount, the Magistrate Judge considered the factors found in S.E.C. v. Byers, 590 F.Supp.2d 637, 644 (S.D.N.Y. 2008) citing SEC v. Fifth Ave. Coach Lines, Inc., 364 F.Supp. 1220, 1222 (S.D.N.Y.1973); accord Code Prods. Corp., 362 F.2d at 673, Coskery v. Roberts & Mander Corp., 200 F.2d 150, 154 (3d Cir.1952)); and 6 A.L.R. Fed. 817, at §§ 7-12 (discussing factors). The factors to be considered are “the complexity of problems faced, the benefits to the receivership estate, the quality of the work performed, and the time records presented.”

         Under the complexity of the case factor, the Magistrate Judge recounted the substantial losses incurred by the investors and the efforts of the Receiver to marshal and protect the remaining assets, which required extensive knowledge of securities regulations, real estate, banking, tax and contract law. The case was particularly complex relating to the nature of the Innotrac stock and the difficulties inherent in trading large volumes of thinly traded stock.

         Furthermore, the Receiver was confronted with the large margin debt Dadante incurred in order to purchase much of the stock. Fast work by the Receiver prevented the brokerage firms, to whom the margin debt was owed, from calling in the debt and liquidating the stock.

         As previously mentioned, the Receiver retained tax professionals to help recover tax refunds for the bilked investors based on the fraudulent statements on the investors gains by Dadante. In fact, the Receiver obtained returns for the investors dating back five years rather than the statutorily limited three year lookback period.

         The Magistrate Judge noted that the Receiver did all this in the face of constant and needlessly extensive opposition by many of the investors to his efforts. In light of the above, the Magistrate Judge found the complexity of the case favored additional compensation.

         The next factor considered by the Magistrate Judge was the time, skill and labor involved in marshaling and securing the assets of the Receivership. Twelve years of working through the case and the obstacles as described above easily satisfies this factor considering the repeated commendations directed to the efforts of the Receiver by this Court and the prior appointing Judge, acknowledging the skill of Receiver and his accomplishments over the protracted litigation.

         The “results achieved” factor described by the Eleventh Circuit in SEC v. Elliott, 953 F.2d 1560, 1577 (11th Cir. 1992) as the “critical factor” was found by the Magistrate Judge to “weigh heavily” in favor of an award of additional compensation. No. party was able to find another Ponzi scheme resulting in 100% recovery of losses let alone an additional 10% recovery for investors on top to date, with more to come. Therefore, the recovery in this matter by the Receiver for the investors can truly be said to be without precedent.

         Finally, the Magistrate Judge found the Receivership assets can easily support the additional award. At the writing of this Opinion, the Receivership assets exceed $5 million dollars.

         In calculating the additional compensation, the Magistrate Judge looked to the ARPC Report and Supplemental Report for average hourly rates for similar work performed. The ARPC Report is an independent audit provided to the Court upon request of the original appointing Judge when the Receiver's fees and reporting were challenged by certain investors. Finding the Receiver's average hourly rate amounted to $225 per hour over the course of the Receivership, the Magistrate Judge compared that rate to those approved by courts in other cases including courts in this district with the range of rates cited in the ARPC Report. The Magistrate Judge concluded the Receiver's rate was a “low hourly rate” when compared to market rates for comparable professionals in this region.

         Noting the Receiver and his professional total billing for the case amounted to a little over $8 million dollars, the Magistrate Judge compared it to a standard 25% contingency fee. Given that the Receivership recovered approximately $48 million, not including the forgiveness he obtained of over $12 million in margin debt, a contingency fee would have resulted in a $12 million fee. Even with additional compensation, the total proposed amount awarded to the Receiver falls short of that amount.

         Using a 30% increase in his average hourly rate, the Magistrate Judge recommended an additional compensation award of $1, 203, 175. The 30% increase is guided by the United States Supreme Court decision in Pennsylvania v. Delaware Valley Citizens Council for Clean Air, 483 U.S. 711 and In Wright Airlines, Inc. 147 B.R. 20, wherein both courts determined fee enhancements should be limited to no more than 30% of the lodestar absent special circumstances.

         Investors' Objections

         Understandably, some investors object to any additional compensation for the Receiver. The Receiver has also submitted objections to the Magistrate Judge's Report and Recommendation.

         The investors' object to the Magistrate Judge's Report and Recommendation because they contend the recommended additional award has no legal authority and the Receiver is not entitled to additional compensation. According to the investors, a Receiver is appointed for the benefit of the beneficiaries and is not entitled to anymore than reasonable compensation. Because the Receiver was paid at his hourly rate, his compensation was necessarily reasonable. Now he seeks funds taken from those same beneficiaries he was appointed to protect. Receiver was paid at his usual and customary rate for over a decade during which time he never complained his rate was unreasonable. ...

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