JOHN P. REITMAN (State Bar No. 80579)
ANDREW S. ROTTER (State Bar No.
86725)
GUMPORT, REITMAN & MONTGOMERY
550 South Hope Street, Suite 825
Los Angeles, California 90071
Telephone: (213)
452-4900
Facsimile: (213)
623-3302
Attorneys for R. Todd Neilson, Trustee of the
Chapter 11 Bankruptcy Estate of Reed E.
Slatkin
RICHARD L. WYNNE (State Bar No.
120349)
JOLEE M. ADAMICH (State Bar No.
196351)
KIRKLAND & ELLIS
777 South Figueroa Street
Los Angeles, California 90017
Telephone: (213)
680-8400
Facsimile: (213)
680-8500
Attorneys for the Official Committee
of
Unsecured Creditors
UNITED STATES BANKRUPTCY COURT
CENTRAL DISTRICT OF CALIFORNIA
NORTHERN DIVISION
In re
REED E. SLATKIN,
Debtor.
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Bk. No. ND 01-11549-RR
Chapter 11
FIRST INTERIM REPORT OF THE TRUSTEE AND THE CREDITORS COMMITTEE
UNDER 11 U.S.C. §§ 1103, 1106(a)(3)-(4)
DATE:
December 17,
2001
TIME: 2:00
P.M.
PLACE:
Courtroom 201
[Judge
Riblet]
[Volumes 1 Through 4 Of Charts And Exhibits Concurrently
Filed Under Separate Cover]
/ / /
/ / /
/ / /
I.
INTRODUCTION
R. Todd Neilson, the trustee (the “Trustee”) of the
Chapter 11 Bankruptcy estate (the “Estate”) of debtor Reed Slatkin (“Slatkin”),
submits this interim report under 11 U.S.C. § 1106 (a) (3)-(4) on the financial
condition and business operations of Slatkin and his Estate. Because the Official Committee of
Unsecured Creditors (the “Committee”) has been very active in the investigation
of these matters pursuant to its authority under 11 U.S.C. § 1103, this report is a joint report of
the Trustee and the Committee and is based on their joint
investigations.
The purpose of this report is to provide information
concerning Slatkin’s assets, liabilities, and financial affairs. In general, the Trustee does not have
personal knowledge of the events described in this report, as he was appointed
after many of the events transpired.
Thus, this report reflects the personal views of the Trustee, his
professionals, and the Committee’s professionals based on their investigation to
date and it is not intended to bind any person or entity and does not result
from a trial or factual determinations on the merits. There may be persons and entities that
strongly disagree with the Trustee’s and the Committee’s assessment of the facts
contained herein or of their respective rights and obligations. Absent a Bankruptcy Court approved
settlement of disputes, if any, between the Trustee and various persons and
entities mentioned in this report regarding their respective rights and
obligations, the Court will ultimately determine the facts and law. The Trustee and the Committee reserve
the right to amend and supplement this report in light of any additional
information that they may receive.
The Trustee and the Committee intend to file additional and supplemental
reports as may be appropriate or directed by the Court.
Although the Trustee, the Committee, and their
respective professionals (the Trustee’s counsel, the Trustee’s accountants and
financial advisors, and the Committee’s counsel (collectively, the
“Professionals”)) have reviewed voluminous documents and financial records, some
documents in their possession have not yet been completely reviewed. Moreover, the Professionals have
conducted very few examinations of witnesses under oath to date, although
informal interviews with certain witnesses have been conducted. Because Slatkin has asserted his Fifth
Amendment privilege against self-incrimination, counsel has not yet been able to
examine Slatkin under oath, although he has been informally interviewed
concerning selected subjects on several occasions by the Trustee, the Trustee's
counsel, and the Committee’s counsel.
While numerous subpoenas to third-party witnesses have
been authorized by the Bankruptcy Court for the production of documents and
several for the examination of material witnesses pursuant to Bankruptcy Rule
2004, most of those examinations have not yet been conducted. Accordingly, in the future, the
Professionals expect to obtain substantial additional documents from third
parties and conduct a substantial number of oral examinations. Information obtained from that future
investigation may support, amplify, modify, or even possibly contradict certain
aspects of the conclusions outlined in this report. In addition, the investigation into the
acts and conduct giving rise to Slatkin’s bankruptcy and the identification and
tracing of assets is an ongoing process.
As that investigation has not been concluded, this report intentionally
omits any discussion of certain areas of ongoing investigation. This report also highlights and
discusses certain assets of the Estate, but does not list or discuss all assets,
such as each stock holding and partnership interest.
II.
SUMMARY OF TRUSTEE'S CONCLUSIONS
Slatkin appears to have conceived and nurtured a
perception or aura that he was a financial wunderkind who graciously bestowed
his investment wisdom upon an exclusive and dutifully grateful
constituency. In actuality, Slatkin
conceived, executed, and perpetrated a massive multi-year fraud on his
investors, using funds from new investors to pay inflated and false returns to
other and older investors, while wasting tens of millions of dollars on
ill-conceived and disastrous investments and paying staggering sums to certain
associates and consultants. Slatkin
sought investors’ funds with the full knowledge that he would be incapable of
providing those returns and that the invested funds would quickly disappear into
the ever expanding vortex of his fraudulent Ponzi scheme. “Generically, a Ponzi scheme is a
phony investment plan in which monies paid by later investors are used to pay
artificially high returns to the initial investors, with the goal of attracting
more investors.” In re
Bonham, 299 F.3d 750, 750 n. 1 (9th Cir. 2000).
Slatkin’s fraudulent scheme was not a recent development
precipitated by the current financial slowdown or the collapse of the dot.com or
high-tech bubble. Rather, it was a
carefully orchestrated charade extending as far back as 1986. Predictably, and inevitably, the Ponzi
scheme grew geometrically in the later years requiring an ever increasing flow
of cash from investors to maintain the illusion of Slatkin's unattainable
financial promises. Ultimately,
Slatkin’s scheme collapsed amidst lawsuits from concerned investors, government
inquiries, and criminal investigations.
While holding himself out to be a highly skilled
investment counselor, Slatkin’s actual financial and investment skill ranged
from unspectacular to dismal until he made a serendipitous investment as one of
the founding investors in Earthlink.
Ex. 1[1]
(Slatkin Depo., p. 146). That
single successful investment in Earthlink propelled Slatkin to a new level of
theretofore unattainable credibility.
Slatkin used that credibility as a further inducement to investors and he
was able to rapidly and aggressively expand the funds under his control, most of
which were quickly dissipated.
The Trustee and the Committee believe that an objective
review of most of the investments remaining in the Estate compels the conclusion
that Slatkin’s opportune investment in Earthlink was an aberration. It is apparent that many millions of
dollars that Slatkin told investors he had wisely invested in business ventures
(for the most part allegedly in publically traded securities) capable of
providing meaningful return have, in fact, been lost in a financial black
hole. When viewing Slatkin’s entire
remaining portfolio of publicly traded securities, an experienced financial
investment counselor with a national investment advisory firm described the
remaining portfolio as “the worst I have ever seen in all of my years of
experience.”
Many of the approximately 800 Slatkin investors have
experienced extreme personal and family economic hardship due to the loss of
their investments, as well as the fact that many investors have informed the
Trustee or the Committee that they dutifully reported and paid taxes on the
profits which Slatkin listed on their respective investor statements, profits
that were completely illusory.
The single most commonly asked question in this case has
been what happened to the money?
From 1986 to 2001, Slatkin received approximately $593 million from
investors. He distributed
approximately $535 million to investors. Of this $534 million, 75 investors
received approximately $279 million, even though they had invested only $128
million, thereby realizing an excess return of approximately $151
million.
From his stock brokerage transfers, Slatkin realized a
gain of approximately $65 million, the vast proportion of which resulted from
sales of his Earthlink stock.
Slatkin expended at least $88 million on various assets and investments,
many of which are illiquid or valueless, and spent approximately $47 million in
“operating” expenses, including taxes.
The “select few,” approximately 75 persons in number,
substantially profited from their financial arrangement with Slatkin. The total amount paid to these investors
from 1986 to 2001, above and beyond their original investments, is in excess of
$151 million or $2 million per investor.
Slatkin paid these funds from commingled accounts, essentially using
other investors’ money, and not profits actually earned on investments. A small number of Slatkin associates
were also able to experience a financial windfall by acting as his
“consultants.” Some of those
“consultants” were paid millions of dollars for ill-defined services. The Trustee is investigating the
recovery of these funds, which represent the greatest single expectation for any
meaningful financial dividend to the unfortunate bulk of investors who did not
share in Slatkin’s largesse. The
Trustee has not initiated any litigation of any kind while he completes his
investigation.
Estimates of creditors’ claims in this Estate have
ranged from approximately $250 million to approximately $800 million. The cause for this wide disparity finds
its genesis in the very nature of the Slatkin Ponzi scheme. Apparently, to persuade investors to
retain their investments and often to invest additional funds, Slatkin
completely fabricated monthly or quarterly statements for investors that
reflected fictitious investments in securities and other assets and cash
reserves, as well as a substantial appreciation from those investments. That phantom appreciation or investment
gains ranged from an average annual return of 24% to as high as 100%. From 1986 to 2001, Slatkin reported
approximately $700 million in bogus profits to investors, of which in excess of
$600 million was falsely reported in the last seven years.
The Trustee believes that creditor claims (investments
net of payments) are approximately $255 million. Investors may have believed, however,
based upon the statements they received from Slatkin, that their investor
accounts had grown to approximately $778 million as of December 31,
2000.
On investor statements, the cumulative value of each
year’s investment appreciation would be added to the principal and thus
compounded. Thus, an unsuspecting
investor who invested $500,000 with Slatkin and received an average return, at
least according to the fraudulent investor statements, of 28% over four years
would have believed that the original investment had ballooned from $500,000 to
a $1,340,000 “nest egg.” In
actuality, there was no such “nest egg,” because Slatkin had used the $500,000
investment to pay fictitious returns, to make unwise investments, and/or to pay
his “consultants” and expenses.
By the end of 2000, the actual funds required to
maintain Slatkin's hypothetical investment structure approximated $130 million
annually. This was an unattainable
sum because Slatkin had dissipated many millions of dollars that had been
entrusted to him and he did not possess the funds required to generate this
large return.
On May 1, 2001, under a barrage of civil lawsuits and
threats by investors (some of whom now sit on the Committee) to file an
involuntary bankruptcy petition, Slatkin filed a voluntary petition under
Chapter 11 of the Bankruptcy Code.
Shortly thereafter, the FBI and the IRS conducted raids authorized by
search warrants on the homes and businesses of Slatkin, and the Ponzi carousel
finally ground to a halt.
III.
SLATKIN’S BACKGROUND
A.
Background
Reed Slatkin was born in a suburb of Detroit, Michigan
on January 22, 1949. According to
Slatkin's SEC deposition testimony, he graduated from the University of Michigan
with a major in Asian languages in approximately 1971. He did graduate work at both Stanford
University and the University of California at Berkeley in languages and
literature. In 1975, he married Mary Jo Slatkin. They have two adult children. Ex. 1 (Slatkin Depo., p.
12).
During Slatkin’s formative years, he became involved in
Scientology, which had been founded by L. Ron Hubbard in the 1950s. In 1975, Slatkin was ordained a minister
in the Church of Scientology (the “Church” or “Scientology”). From 1974 through approximately 1984,
Slatkin and his wife did volunteer work for the Church on a full time
basis. Ex. 1 (Slatkin Depo., p.
39). Their income during this
period was insignificant.
Id.
While the underlying issues in the Slatkin bankruptcy
case are primarily economic, not religious, it would be difficult to imagine a
more dominant force in the life of Slatkin than Scientology. It would be fair to say that Scientology
permeated almost every aspect of his life.
It appears that most of Slatkin’s early, as well as present, business
associations relate to his affiliation with Scientology, and a large number of
the present investors came to Slatkin for advice because of their mutual
involvement with Scientology.
B.
Slatkin’s Early Investment Experiences
In about 1979-1980, Slatkin met Robert F. Duggan
(“Duggan”), a fellow Scientologist, who Slatkin describes as “a successful
professional investor, primarily in the stock market.” Ex. 1 (Slatkin Depo., p. 40). Slatkin had no prior formal training in
investments and money management, and it was Duggan who provided Slatkin with
rudimentary investment training.
During this period, Duggan began to teach Slatkin about the stock market
and the process of analyzing companies as potential investments. Ex. 1 (Slatkin Depo., pp. 40-42,
173-74).
In about 1984, Slatkin made the transition from
full-time ordained minister to that of professional self-employed investor. At about the same time, Slatkin began
making investments for “friends.”
Ex. 1 (Slatkin Depo., p. 180).
At first, Slatkin had a dozen or fewer “friends” who invested money with
him. Id. Slatkin described these investor
“friends” to the Securities and Exchange Commission (“SEC”) as “people who were
spending their time working in the church, or working to help the church, or
working to get themselves off this bridge . . . , or training themselves” in
Scientology. Id. p.
124. According to Slatkin, he
“wasn’t ever looking for anybody [to make investments for] except people that
were associated with the church, who came to me.” Id., p. 235. Slatkin’s purported criterion was
“someone who was associated with the church, who was working to help the
church.” Id. His professed purpose in making
investments for these “friends” was “to help the Scientologists who have their
attention away from their money and they’re helping the church.” Id., p.
238.
In connection with an audit of his 1983 and 1984 tax
returns, Slatkin wrote a note stating that he “never intended and in fact did
not ever receive money for doing this.”
Ex. 2. Slatkin further
explained that the individuals on whose behalf he was investing were his
relatives or associates and the association was primarily designed to reduce
brokerage fees through the joint buying of stocks.
It was reportedly in about 1985 that an attorney named
Dan Lang drafted a form letter for Slatkin’s “friends” to sign when they began
to invest with Slatkin; the letter reads:
“Dear _____, You have asked
me to do you a favor and invest some of your money as a friend . . . .” Ex. 1 (Slatkin Depo., p. 196);
see Ex. 3 (Sample Investor Letter).
According to Slatkin, everyone who invested with him signed this letter
(Ex. 1, Slatkin Depo., p. 197), and numerous persons who had no prior connection
with Slatkin signed this letter so that Slatkin would make investments for
them.
C.
The Ponzi Years:
1986-2001
In 1985, Slatkin was in the process of becoming an
established money manager. At that
time, Slatkin met Ronald Rakow (“Rakow”) and Chris Mancuso (“Mancuso”), and they
invested money with Slatkin. Ex. 3
(Rakow Depo., p. 190, 191, 315).
Rakow and Mancuso were involved in a company called Culture Farms. In 1985, Culture Farms was the subject
of a criminal investigation and was subsequently placed into receivership. Rakow and Mancuso were convicted of
criminal conduct arising out of their involvement with this company. Ex. 3, p. 229.
By late 1986, Slatkin estimates that he was managing
about $7-8 million for his “friends.”
Ex. 1 (Slatkin Depo., p. 193).
In August 1987, Slatkin met Richard Levine (“Levine”),
who was then a stockbroker at Prudential-Bache Securities. Slatkin showed Levine the performance of
his “investment pool” which boasted a 40%-50% return and demonstrated to Levine
a computer program that he claimed automatically flagged stocks to buy and sell
based on certain market developments and other criteria. Levine, impressed by the software and
the returns, decided to enter into a business arrangement with
Slatkin.
In February 1988, Slatkin and Levine entered into a
tentative transaction with John and Amy Jo Gottfurcht (“Gottfurcht”). Ex. 5. Gottfurcht had an existing money
management company called Statistical Sciences Inc. (“SSI”), an investment
advisory firm registered with the SEC, and he claimed to control over $100
million in client funds. The SSI
transaction called for Slatkin and Levine to acquire a 25% interest in SSI and
for Slatkin to contribute the license to use his software to SSI. Id. As part of the proposed transaction, an
independent audit was made of certain aspects of the business, including
Slatkin’s trading results of 40%-50% returns. The audit ultimately concluded that
Slatkin’s statements and trading records were not correct and Slatkin admitted
to falsifying those records.
Slatkin also had a business association with Patrick
Gallagher (“Gallagher”) during 1986-1990.
Gallagher was a commodities trader licensed with the Chicago Board of
Trade. Slatkin and
Gallagher came to an agreement whereby Slatkin would make funds available to
Gallagher, who was properly licensed, to make the trades. Ultimately, a bitter dispute arose
between them relating to capital accounts and tax allocations. In the final exchange Gallagher’s
attorney intoned, “We are fearful that a comprehensive review of certain trading
and account activity may reveal unsavory characteristics of a scabrous nature
involving, among other things, irregularities with respect to the exchange rules
and conduct, which, under closer scrutiny, may subject one to prosecution by
various government agencies.” Ex. 6
(¶ 7).
Over the years, Slatkin’s reputation grew, based upon
the falsified returns of his portfolio, and people sought out his expertise in
ever growing numbers and he had an increasing amount of money under his
control. In 1994, Kevin O’Donnell
(“O’Donnell”) convinced Slatkin to invest in Earthlink. Within three years, Earthlink became a
dot-com success story and Slatkin’s Earthlink stock in the company was worth
over $100 million; however, that stock was restricted and was not freely
transferable. Slatkin’s Earthlink
investment enhanced his credibility with investors.
During the 1990s, Slatkin received hundreds of millions
of dollars. He and his family lived
in a large estate in Santa Barbara and employed an estate manager to tend to the
property. They took vacations to
Europe and Hawaii, belonged to an elite country club, and their social circle
included some of Santa Barbara’s wealthiest and most influential people. Reed Slatkin had
“arrived.”
During this period Slatkin was investing in a wide array
of real estate developments throughout the United States, film and production
companies, investment partnerships, and securities in a variety of
companies. Most of these
investments would prove to be financial disasters.
Unfortunately, for both Slatkin and his investors, with
the exception of Earthlink, Slatkin’s financial castle was built upon the
shifting sands of lies and misrepresentations. The fissures started to be exposed in
1999.
As discussed in greater detail in the following section
of this report, in late 1999, the SEC began a formal investigation into
Slatkin’s activities to determine if he was as acting as a paid investment
advisor who was required to be registered as such under federal law. In an attempt to convince the SEC of his
intention to remove himself from the area of money management, in January 2000
Slatkin told the SEC that $300 million of investor funds was in overseas
accounts in Switzerland and that he was in the process of liquidating those
accounts to pay off his investors, closing investors’ accounts, and referring
investors to licensed money managers.
Ex. 1 (Slatkin Depo., p. 212).
To date, the Trustee and the Committee have found no
evidence to confirm the existence of those foreign accounts or the transfer of
substantial funds abroad. Instead,
it appears that Slatkin’s representations to the SEC were a further extension of
the ruse in which he had been engaged since 1986. Moreover, between January 2000 and April
2001, Slatkin had not stopped his investment activities but had taken in over
$135 million in order to maintain the financial charade.
Between 1986 and 2001, Slatkin had approximately 800
investor “friends” who had given him as much as $593 million to invest for
them. Periodically, Slatkin
provided his investors with statements that purported to show the securities
that Slatkin held for their benefit.
Ex. 1 (Slatkin Depo., pp. 187-88).
Those statements showed glowing results - - that Slatkin regularly and
uninterruptedly made money for the investors both in good and bad economic
conditions. Although Slatkin
purchased some of the securities reflected on those statements, the vast
majority of those purported holdings did not exist and the gains reported on
those statements were illusory.
Slatkin regularly “doctored” real brokerage account statements in an
apparent effort to support the existence of fictitious investments and
profits. The unfortunate reality is
that Slatkin operated a Ponzi scheme cloaked as legitimate and highly profitable
investment advice.
IV.
PROCEDURAL BACKGROUND
A.
The Securities and Exchange Commission Investigation of SlatkinA.
The Securities and Exchange Commission Litigation Against
Slatkin
In 1997, the SEC began an informal investigation of
Slatkin’s investment activities.
Ex. 1 (Slatkin Depo., pp. 122-23).
The SEC launched its formal investigation of Slatkin in
1999.
In his examination by the SEC in 2000, Slatkin falsely
testified under oath that he was discontinuing his investment operations: “This process of liquidating accounts is
now in full swing.” Ex. 1 (Slatkin
Depo., p. 125). “I am not accepting
any new accounts or any money from existing accounts. And I plan to transition to close or
liquidate all accounts over the next few months.” Id., p. 131. In fact, while Slatkin was paying
certain of his investors their purported account balances, at the same time, he
was continuing to take in millions of dollars from other “friends.” As noted above, during 2000 until he
filed bankruptcy, Slatkin took in some $135 million from
investors.
Slatkin also represented to the SEC and to certain of
his investors that he had hundreds of millions of dollars of investor money in
Switzerland. According to Slatkin’s
testimony before the SEC, in 1987, he began moving his “friends” money to a
company called NAA Financial (“NAA”) in Switzerland. Ex. 1 (Slatkin Depo., p. 195). All of this money purportedly was in
Slatkin’s name in two accounts, one for Slatkin and one for his “friends.” Id., pp.
210-12.
In early 2000, Slatkin also testified that, in
approximately 1990-91, he deposited $12-15 million into his own account at
NAA. Ex. 1 (Slatkin Depo., p.
221). In addition, he testified
that he had not made deposits into either of the NAA accounts in the last 12
years (i.e., since 1988).
Id., pp. 231-32.
Finally, Slatkin represented that, in 2000, there was $300 million in
his personal account with NAA.
Id., p. 212.
Based upon the Trustee’s investigation to date and
investigations conducted by certain of Slatkin’s investors, Slatkin’s story was
a complete fabrication. It also
appears that NAA does not exist. At
the very least, investigators have not been able to identify any such
company. Investigators also
determined that Slatkin’s purported NAA accounts with Union Bank of Switzerland
do not exist. Although Slatkin
hired Ernst & Young to audit NAA’s books in Switzerland, apparently there is
no such audit report.
There also is currently no evidence that Slatkin
directly transferred any large sums of money to Switzerland in 1987-1989. Moreover, it is clear that Slatkin was
attempting to create the false image of Swiss accounts to mislead the SEC and to
delay or derail its investigation.
In the midst of his SEC investigation, Slatkin used International
Telecommunications Consulting, LLC (“ITC”) to set up a telephone line that
forwarded calls made to a Swiss telephone number to Santa Barbara, where they
were answered. In February 2000,
Chris Mancuso, who apparently owned ITC, wrote to Slatkin concerning the
telephone line: “when you dial the
number the line has been conditioned to provide a truly genuine European ring
(nice touch, huh?).” Ex.
7.
On May 11, 2001, ten days after Slatkin filed
bankruptcy, the SEC commenced a formal action entitled Securities and
Exchange Commission v. Reed E. Slatkin, Case No. 01-4283 RSWL (MANx), in the
United States District Court for the Central District of California, Western
Division (the “SEC Enforcement Action”).
In its complaint, the SEC alleged that Slatkin was unlawfully operating
as an unregistered investment advisor and that he had and was engaged in
transactions, acts, practices, and courses of business in violation of federal
securities laws.
On May 18, 2001 the United States District Court entered
a Preliminary Injunction against Slatkin and froze his assets. Ex. 8. In substance, ¶ 6 of the Preliminary
Injunction enjoined Slatkin from transferring “any funds, assets, securities,
claims, or other property, owned by Slatkin, including such funds, assets,
claims or other property that he controls or has possession of or custody
of.” In support of the Preliminary
Injunction, the District Court entered Findings of Fact and Conclusions of Law
(“SEC Findings”). Ex.
9.
On May 29, 2001, Slatkin signed a Consent of Defendant
Reed E. Slatkin to Entry of Judgment of Permanent Injunction and Other Relief
(the “Consent”). Ex. 10. In executing the Consent, Slatkin agreed
that he would not deny any allegation in the SEC’s complaint or create the
impression that the complaint was without factual basis. Id., ¶ 8. Based thereon, on June 7, 2001, the
District Court entered its Judgment of Permanent Injunction and Other Relief
Against Defendant Reed E. Slatkin (the “Judgment”). Ex. 10. The Judgment permanently enjoined
Slatkin from further violating the federal securities laws as alleged in the
SEC’s Complaint. It also
permanently froze, among other assets, all monies and assets held in the name of
or for the benefit of Slatkin or any of his affiliates. Id., ¶ VII. At the Trustee’s suggestion, the
Judgment subsequently was modified to make clear that third parties holding
assets subject to the Judgment were required to cooperate with the Trustee. Ex. 11.
Although the Judgment required that Slatkin give the SEC
“a detailed and complete schedule of all of his assets, foreign or domestic,
including the source of such assets” (Ex. 10, ¶ XI), to the best of the
Trustee’s knowledge Slatkin still has not done so.
B0
Litigation Against Slatkin
In early 2001, before the SEC commenced litigation
against Slatkin, certain of Slatkin’s investors became alarmed about their
inability to obtain the return of money that Slatkin purportedly had invested
for them.
1
1.
The Poitras Litigation:
In February 2001, an investor
named John Poitras transferred $10 million to Slatkin for investment. Instead of making investments for
Poitras, Slatkin, as he had typically done, used the bulk of those funds to pay
off other investors and to pay personal expenses. Ex. 9 (SEC Findings ¶ 10-11). Later that month, Poitras requested the
return of his money. After Slatkin
stalled and was not able to repay Poitras, Poitras commenced litigation against
Slatkin on April 11, 2001. Ex. 12
(Poitras Dec.). In that litigation,
Mr. Poitras served writs of attachment to freeze Slatkin’s assets. Ex. 13.
2
Arthur and Lois Berke Litigation: Between 1996 and 1999, Arthur Berke
invested about $700,000 with Slatkin; he later invested another $2 million. Ex. 14 (Berke Decl., ¶¶ 3-14). In April, 2001, Arthur and Lois Berke
filed suit in the Los Angeles Superior Court alleging causes of action against
Slatkin for fraud and breach of contract.
Ex. 15.
3
The Wesley West Litigation: On April 19, 2001, Wesley West Flexible
Partnership and others (all affiliates of the Stedman family) commenced
litigation entitled Wesley West Flexible Partnership [et. al.] v.
Slatkin, Case No. 01-03628 RSWl (MANx) in the United States District Court
for the Central District of California.
Ex. 16. The Wesley-West
group also sought to obtain writs of attachment against
Slatkin.
Counsel for Poitras and Stuart Stedman, among others,
participated in meetings with Slatkin's representatives during the last week of
April, 2001, and participated in an informal group of creditors that
successfully negotiated for Slatkin to file this bankruptcy case, to turn over
voluminous documentation to Deloitte & Touche (which was to safeguard the
documents and have them imaged), and to turn over his passport to Slatkin's
counsel. Poitras and Stedman
are now members of the Committee.
Wesley West's counsel has now become Committee
counsel.
C0
Slatkin’s May 1, 2001 Voluntary Petition for Relief; Appointment of
the Trustee
On May 1, 2001, Slatkin commenced this bankruptcy case
by filing a voluntary petition for relief.
Slatkin filed his petition only after (1) the SEC had been
formally investigating him for a year and a half; (2) he had been sued by
Poitras, the Berkes, and the Wesley West group who had invested tens of millions
of dollars with him; and (3) certain of his creditors had threatened
to file an involuntary bankruptcy petition if Slatkin did not voluntarily file
bankruptcy.
In a chapter 11 bankruptcy case, generally the debtor
remains in possession of his assets and may continue to operate his business
with a view toward reorganizing the business. However, in certain circumstances
defined in 11 U.S.C. 1104(a), the
Bankruptcy Court may order the appointment of an independent chapter 11 trustee
to administer the debtor’s assets and operate his business. The circumstances in which the
appointment of a chapter 11 trustee is appropriate include fraud, dishonesty,
incompetence, or gross mismanagement of the affairs of the debtor either before
or after the commencement of the bankruptcy case.
On May 10, 2001, certain of Slatkin’s creditors filed a
motion in the Bankruptcy Court for the appointment of an independent chapter 11
trustee; and on May 14, 2001, the United States Trustee filed her own motion for
the same relief. The latter motion
was set for hearing on an expedited basis on May 16,
2001.
Immediately prior to the May 16 hearing, Slatkin sought
to convert his chapter 11 reorganization case to a chapter 7 liquidation
case. Three significant
consequences of conversion from chapter 11 to chapter 7 are that (1) an
independent trustee is automatically, and randomly, appointed to administer the
debtor’s assets and pay creditors; (2) if a chapter 7 creditors committee
is appointed, it cannot retain counsel at the expense of the bankruptcy estate;
and (3) distributions to creditors from a chapter 7 bankruptcy estate
generally takes years. Accordingly,
if the Bankruptcy Court had permitted Slatkin to convert his case to chapter 7,
the Committee would have been without a viable means of employing counsel or
continuing its investigation, and the creditors would not have the opportunity
to file a chapter 11 liquidating plan, in order to begin earlier
distributions.
At the May 16 hearing, the Bankruptcy Court determined
not to permit Slatkin to convert his case to chapter 7. The Court then ordered the appointment
of a chapter 11 trustee and the U.S. Trustee made the appointment of R. Todd
Neilson as the chapter 11 trustee.
D0 The
Official Committee of Unsecured Creditors
The Bankruptcy Code also provides for the appointment of
a committee of creditors holding unsecured claims and for counsel for that
committee in a chapter 11 case.
11 U.S.C. § 1102. The
retention of such counsel is subject to Bankruptcy Court approval, and their
fees and expenses are payable by the bankruptcy estate after notice and hearing
and upon order of the Bankruptcy Court.
In this case, the Committee has been appointed and it
has retained counsel pursuant to Bankruptcy Court order entered on or about May
10, 2001. The Committee has
six members who, along with their affiliates and associates, collectively hold
claims against the Estate in the approximate amount of $115 million for funds
they invested with Slatkin, net of any payments received.
V
HIGHLIGHTS OF THE FORENSIC INVESTIGATION
A0
Introduction
Ronald Rakow, a close business associate of Slatkin,
advised Slatkin in a memo, “Remember you live and thrive in a world of adulation
& respect. In a brutally frank
critique and examination you will be found to be a Human . . . .” Ex. 17. The primary source of this “adulation
and respect” was Slatkin’s supposedly “proven” prowess as a financial advisor
who consistently provided double-digit annual returns on investments tendered to
his care. Through their analysis of
millions of documents and transactions, the Trustee and his professionals have
made the “brutally frank critique and examination” of which Rakow warned. In essence, “the truth is in the
numbers.”[2]
In order to make the required analysis of Slatkin’s
financial affairs, NE first had to secure the records of Slatkin and related
entities. That task was accomplished through coordination with the FBI, the IRS
Criminal Division, Justice Department lawyers, and legal counsel for both the
Trustee and the Committee. The
Trustee obtained more than 300 boxes of records which are maintained in a
centralized document center. In
addition, voluminous data was downloaded from Slatkin’s computers; and the
Trustee and his counsel obtained substantial additional records from third
parties such as banks, brokerage firms, and other businesses, both through the
issuance of Rule 2004 subpoenas and informal document
productions.
Once the records were available for review, NE commenced
its analysis. To date, NE has
examined the approximately $1.5 billion which flowed between 63 bank accounts
and 318 brokerage accounts (see Exs. 18 and 19); and under the direct
supervision of Mr. Judd, 9 people have spent over 6000 hours analyzing and
dissecting Slatkin’s financial dealings over a 15-year period. In all, NE has reviewed literally
millions of pages and related financial documents. The financial investigation is ongoing
and will continue during the pendency of this bankruptcy case. However, a significant amount of the
financial information that has been gleaned illuminates, both for the Court and
other interested parties, Slatkin’s scheme.
B0
Investment Procedure and Income Reporting
After an investor opened an account with Slatkin,
Slatkin typically provided quarterly “statements,” which he carefully crafted in
order to create the impression that Slatkin had made highly profitable
investments and stock trades, generally averaging annual returns of from 25% to
50%. See Ex. 20. Obviously pleased, investors often
transferred additional funds to Slatkin or simply did not withdraw funds from
their accounts as they watched their wealth grow geometrically year after year
(at least according to Slatkin’s quarterly statements). Many of Slatkin’s investors had a sense
of financial well-being that was finally jarred from its moorings by his
bankruptcy.[3]
NE’s analysis confirms that the statements sent to
investors were, by and large, completely fraudulent. The returns reflected in those
statements were inflated or non-existent.
Virtually none of the reported trades had been made, and the securities
which supposedly were held in the investors’ accounts had never been purchased
or had been purchased in far smaller quantities than Slatkin reported. Similarly, Slatkin’s other oral and
written representations concerning his investment returns were utterly false and
fraudulent.
As an example, the following Schedule compares the
profits reported to investors with those actually reported on Slatkin personal
tax returns for the calendar year 1995.
|
REED E.
SLATKIN | |||||||
|
All Investors ‑ All
Accounts | |||||||
|
Summary of Activity
for the Year Ended December 31, 1995 | |||||||
|
|
|
|
|
| |||
|
|
|
Amounts |
| ||||
|
Activity as
Reported to Investors |
|
| |||||
|
|
| ||||||
|
|
Investor Account
Balances ‑ December 31, 1994 |
|
$
133,663,272 |
| |||
|
|
(383
Investor Accounts) |
|
|
| |||
|
|
| ||||||
|
|
Add: Investor Cash
Receipts |
|
32,058,091 |
| |||
|
|
|
|
|
| |||
|
|
Deduct: Investor Cash
Disbursements |
|
(23,421,246) |
| |||
|
|
|
|
|
| |||
|
|
Profits Reported to
Investors |
|
67,819,920 |
| |||
|
|
|
|
|
| |||
|
|
Investor Account
Balances ‑ December 31, 1995 |
|
|
| |||
|
|
(484
Investor Accounts) |
|
$
210,120,038 |
| |||
|
|
|
|
|
| |||
|
Adjusted
Income/Profit as Reported on Tax Returns (note
2) |
|
|
| ||||
|
|
|
|
|
| |||
|
|
Interest
Income |
|
$
465,079 |
| |||
|
|
Dividend
Income |
|
152,265 |
| |||
|
|
Income (losses)
from k‑1's |
|
(793,139) |
| |||
|
|
Consulting Business
Expenses (note 3) |
|
(1,298,459) |
| |||
|
|
Short‑term/Long‑term
Gains (losses) |
|
1,943,162 |
| |||
|
|
Miscellaneous
|
|
(51,675) |
| |||
|
|
|
|
|
| |||
|
|
Adjusted Income/Profit as
Reported |
|
$
417,233 |
| |||
|
|
|
|
|
|
|
|
|
|
|
Note 1: The amounts as reported on Reed E.
Slatkin's personal tax return for the year materially agree to activity
from actual cash receipt and disbursement detail, brokerage accounts and
partnership k‑1's. These
amounts are representative of actual results. |
| |||||
|
|
| ||||||
|
|
| ||||||
|
|
| ||||||
|
|
Note 2: Includes both Reed E. Slatkin's
personal return and Slatkin Investment Club. |
| |||||
|
|
Note 3: Reed Slatkin's personal tax return
includes consulting income from investors. These payments which are
classified as income for tax purposes are classified as ordinary
investment receipts from investors and reported as such to the
investor. Accordingly, they
are not included as income for purposes of this
analysis. |
| |||||
|
|
Source: Books and records of the
Debtor |
|
|
|
|
|
|
As the above Schedule reveals, Slatkin began 1995 with
383 investor accounts and ended the year with 484 accounts (a net increase of
101 accounts). During that period
he reported to investors that they had made profits of approximately $68
million, i.e., a purported annual return of 49.15%. In fact, Slatkin overstated the profits
by $67.5 million, having gained only approximately $400,000 on funds still in
his care.
The Schedule below reflects the annual rate of return,
as reported by Slatkin, from 1994 through 2000. Those returns ranged from 19.68% to
49.15%. The Trustee believes that
those returns were, by and large, imaginary -- the result of Slatkin’s
systematic fraudulent reporting of non-existent gains and income. In fact, Slatkin did not generate gains
on his entire investment portfolio; he generated massive losses. Moreover, all of the funds which Slatkin
received from investors were commingled and used for whatever purpose he
determined at the time.
/ / /
/ / /
/ / /
|
REED E.
SLATKIN | |||||||
|
All Investors ‑ All
Accounts | |||||||
|
Summary of Activity for
the Years 1994 through 2000 | |||||||
|
| |||||||
|
|
|
|
|
Amounts |
|
Number of
Accounts |
Estimated
Annual Rate of
Return |
|
Activity as Reported to
Investors |
|
|
|
|
| ||
|
|
Investor Account
Balances ‑ December 31, 1993 |
$ 91,848,540 |
|
297 |
| ||
|
|
|
Add: Investor Cash
Receipts |
|
26,236,410 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(18,147,333) |
|
|
|
|
|
|
1994 Profits Reported
to Investors |
|
33,725,656 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1994 |
133,663,272 |
|
383 |
35.05% | ||
|
|
|
Add: Investor Cash
Receipts |
|
32,058,091 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(23,421,246) |
|
|
|
|
|
|
1995 Profits Reported
to Investors |
|
67,819,920 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1995 |
210,120,038 |
|
484 |
49.15% | ||
|
|
|
Add: Investor Cash
Receipts |
|
42,290,351 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(38,476,105) |
|
|
|
|
|
|
1996 Profits Reported
to Investors |
|
62,671,772 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1996 |
|
276,606,056 |
|
623 |
29.56% | |
|
|
|
|
|
|
|
|
|
|
|
|
Add: Investor Cash
Receipts |
|
66,588,599 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(42,295,853) |
|
|
|
|
|
|
1997 Profits Reported
to Investors |
|
86,935,289 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1997 |
|
387,834,092 |
|
757 |
30.11% | |
|
|
|
Add: Investor Cash
Receipts |
|
100,113,775 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(76,279,109) |
|
|
|
|
|
|
1998 Profits Reported
to Investors |
|
109,740,117 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1998 |
|
521,408,875 |
|
762 |
27.45% | |
|
|
|
Add: Investor Cash
Receipts |
|
97,614,364 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(101,817,431) |
|
|
|
|
|
|
1999 Profits Reported
to Investors |
|
138,970,796 |
|
|
|
|
|
Investor Account
Balances ‑ December 31, 1999 |
|
656,176,604 |
|
774 |
26.76% | |
|
|
|
Add: Investor Cash
Receipts |
|
102,620,503 |
|
|
|
|
|
|
Deduct: Investor Cash
Disbursements |
|
(109,074,273) |
|
|
|
|
|
|
2000 Profits Reported
to Investors |
|
128,522,538 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investor Account
Balances ‑ December 31, 2000 |
|
778,245,372 |
|
734 |
19.68% | |
|
|
|
|
|
|
|
|
|
C0 Reed
Slatkin Investment Club:
1998
In 1990, Slatkin registered the Reed Slatkin Investment
Club as a dba in Los Angeles County.
On March 3rd of that year, he also formed a limited partnership called
the Reed Slatkin Investment Club, LP (“RSIC”), of which Slatkin was the sole
general partner. Ex. 21. Most of the RSIC accounts were in the
name of various retirement plans; and it appears that Slatkin formed RSIC for
retirement funds that were being invested for the long-term, so that he could
expect that, in any given year, only a small percentage of the funds would be
withdrawn.
As a further example of how Slatkin falsely reported
gains to investors, NE analyzed RSIC’s investment structure, comparing its 1998
financial results, as reported by Slatkin, with its actual results. As detailed in Exhibit A, as of January
1, 1998, there were 64 investors with a reported $45,110,218 in their retirement
accounts. Slatkin added seven new
accounts during the year. None were
closed. Therefore, at the end of
the year, Slatkin controlled 71 accounts through RSIC.
During the year, RSIC reported profits to investors of
$10,446,643, which he added to their individual account balances. The records further reflect that he
returned $4,319,228 to investors during the year. Thus, according to the quarterly
statements that investors received from either Union Bank of California or Santa
Barbara Bank & Trust, the aggregate value of their accounts at the end of
1998 was $51,237,633.
A review of the purported $10,446,643 profit during the
year reveals that it “consisted” almost entirely of fictitious interest from a
Union Bank account, fabricated dividends, and bogus stock sales. Slatkin attributed to investors’
accounts their share of interest on a purported $21,992,980 on deposit in a
Union Bank account as of December 31, 1998. However, the actual cash balance in that
account on that date was only $9,950.
As
reflected in the following Schedule, Slatkin overstated RSIC’s cash by
$21,983,029, reporting that RSIC held $24,173,478 compared to the $2,190,449 it
actually held. According to
Slatkin’s statements, the aggregate value of securities in RSIC accounts, listed
at cost, was $24,508,272, but securities actually held by RSIC were worth only
$834,801 — a net overstatement of $23,673,471. Slatkin told his RSIC investors that
unrealized gains on their holdings totaled $4,140,004, despite the fact that
there was an actual unrealized loss on stocks of $431,525 – a net overstatement
of $4,571,529. Finally, the total
amount of investor retirement accounts was purportedly $51,237,633, when it was
actually only $2,593,724 – a net overstatement of
$48,643,909.
|
REED E.
SLATKIN | |||||
|
Slatkin Investment
Club | |||||
|
Comparison of
Actual to Reported ‑ Balance Sheet | |||||
|
As of December 31,
1998 | |||||
|
|
|
|
|
|
|
|
|
|
|
Balances |
Actual |
|
|
|
|
|
As
Reported |
Balances |
|
|
|
|
|
12/31/98 |
12/31/98 |
|
|
|
|
|
|
|
|
|
Assets: |
|
|
|
| |
|
|
Cash ‑ Union Bank ‑
Highmark |
|
$
21,992,980 |
$
9,950 |
|
|
|
Cash ‑ Santa
Barbara Bank |
|
515,846 |
515,846 |
|
|
|
Cash ‑ Imperial
"Prin Cash" |
||||