familyownedbusinessblog

IF AN INVESTMENT SOUNDS TOO GOOD TO BE TRUE….IT PROBABLY IS…

Investors should exercise caution when investing in something that promises an unbelievable rate of return or is presented as a "sure thing."

Investors could unwittingly fall into a financial nightmare if they innocently invest in what later turns out to be Ponzi scheme. On a national level, almost everyone is now familiar with the multi-billion dollar Ponzi scheme perpetrated by Bernie Madoff.   In the Pacific Northwest, Ponzi schemes run by Seattle based money manager Darren Berg and Kirklandbased broker Rhonda Breard have made headlines this past year.  

State Court appointed Receivers or Bankruptcy Trustees have been appointed in many Ponzi scheme cases to marshal assets for all potential creditors of the investment company used to perpetrate the Ponzi scheme. This marshalling of assets can include obtaining a return of an innocent investor’s gains on a Ponzi scheme investment under a fraudulent transfer theory.   

An investor bears the burden of proof to show that they were an innocent investor to protect their initial principal investment amount. If the investor cannot satisfy that burden, the Receiver/ Trustee could obtain a judgment ordering the return of the initial principal amount. There is a further possibility of accrued interest and attorneys’ fees being awarded to the Receiver / Trustee if the matter is contested. The case law is weighted very heavily in favor of the Receiver/ Trustee in such instances.

AW Attorneys Roger T. Dunaway and Rob Roy Smith recently represented an investor in what turned out be to a Ponzi scheme involving Indonesian oil fields. A court appointed Receiver filed suit against all investors seeking, at a minimum, a return of each investor’s “excess proceeds” plus accrued interest.

 The AW client initially invested about $750,000.00 in the oil fields and received investment proceeds of about $800,000.00 over a 2 year period. At a minimum, the AW client was looking at potential exposure in excess of $1,300,000.00 ($800,000.00 excess proceeds plus 4-5 years accrued interest on that amount at 12% per annum). If the client had wanted to fight the claims, the Receiver was prepared to also seek the $750,000.00 initial principal investment amount forcing the investor to prove that they were an innocent investor, thus, bringing the Receiver’s claim to over $2,000,000.00. Counsel was able to quickly resolve this case for $500,000.00 (payable over 5 months) to avoid much higher exposure.

 

Minimize Risk From Investment Fraud

Mark Castelin is Director of Harris myCFO Investment Advsory Services, LLC, and Debra Doran is Managing Director, Harris my CFO, Inc.  Mark and Debra took my law partners, June Wiyrick Flores, Roger Dunaway, George Bonini, and me through their due diligence in the investment management process which they call: “Who Watches The People Who Watch Your Investments?; What You Need to Know and Do To Minimize Risk From Investment Fraud.”  They have an impressive process and gave me permission to share some key warning signs and questions to ask investment advisors. 

The Key Warning Signs:

•  Consistently great returns: Unrealistic return expectations from marketers or a past track record that is too good to believe.
• Lack of Transparency: Little or no visibility as to how they generate their investment returns.
• Unknown Auditor: Auditor being used is either unknown or affiliated with investment manager.
• Lack of Independent Custodian: Investment Advisor has custody of the assets.
• Lack of Track Record: Individuals involved in the investment have no direct experience managing the strategy they are marketing.
• Control of Information:  Only one person has knowledge of assets included and investors.

Key questions to ask: 

• What type of alternative approach does the advisor use (direct/pooled or fund of fund) and why?
• How many investment professionals are involved in the due diligence process? What are their backgrounds and experience?
• Do they supplement their process with the use of outside consultants? If yes, what specific services do they provide?
• Do they use a centralized approved list?
• Provide a checklist of due diligence program.
• What type of oversight exists to ensure due diligence process is adhered to? 

Heading the warning signs and asking the key questions will reduce the risk of investing with an unscrupulous advisor. But these are only two legs of the three legged-stool. The third leg is the investors willingness to heed the warning when the advisor is a trusted friend and/or trusted professional. This third leg is the weakest. To strengthen this leg, get a second opinion.

Keeping it in the Family

Many clients with family businesses or with assets that they want to remain within their family's bloodline are concerned about how to leave those assets to their family members upon their death.  These clients fear that the assets will be transferred to the child's or grandchild's spouse through gift or divorce. 

One solution is to retain these assets in trust for the lifetime of the child or grandchild and limit the distributions to income only.  This may not be an ideal option for some who want their family to have the economic benefit of those assets. 

Another solution is to include a requirement in the estate planning documents that the beneficiary must have a prenuptial agreement or other type of asset protection agreement as a condition to receiving a principal distribution.  The purpose of the prenuptial agreement is to restrict the ownership of the family assets to the bloodline.  The prenuptial agreement can be limited to the assets that the beneficiary is inheriting.  If the beneficiary does not have a prenuptial agreement or other asset protection agreement, then the beneficiary will not receive any principal distributions. 

The estate or trust should include discretion for the trustee to pay for the reasonable attorney fees for  both the beneficiary and the beneficiary's spouse that will be incurred to adopt a prenuptial agreement.  The trustee should also have discretion to purchase a life insurance policy on the life of the beneficiary that is payable to the beneficiary's spouse. 

The prenuptial agreement is not a perfect solution because once the beneficiary receives the principal distribution, the beneficiary can terminate the agreement or, subject to transfer restrictions on the assets, transfer the assets to the spouse.  It is equally as important that the children and grandchildren are raised with an understanding or expectation that this is how our family manages the family assets - everything remains in the bloodline.  Along with this,it is important that the family members and future spouses understand that this is expected of all family members and their spouses. 

Join us for an employee benefits seminar on 9/17 at Bridgeport Brewing

Our Labor & Employment Group is hosting a seminar entitled "20/20 Benefits Planning for 2010" on 9/17 at Bridgeport in the Pearl.  For more info on the event, go here. 

Asset Protection Trusts

A common misconception is that a trust provides asset protection for the person who created the trust.  Generally, that is incorrect.  Most trusts do not provide asset protection for the settlor (the person who creates the trust).  When a settlor creates a revocable trust (a trust that the settlor may change) the settlor's creditors have the right to access the trust's assets to satisfy claims against a settlor.  If a settlor creates an irrevocable trust (a trust that cannot be modified) and the settlor is a beneficiary of that trust, the general rule is that the settlor's creditors can reach the trust's assets.  

However, if a settlor establishes an asset protection trust (APT), the APT can provide liability protection to the settlor for the trust assets and the settlor may have limited access to those assets. There are generally two types of APTs – foreign and domestic.  A foreign trust is one that is established in a country other than the

United States

.  A domestic trust is one that is established and governed by the laws of a state in the United States. There are less than 15 states that have provisions for an APT.  Each state has different rules and requirements to create an APT. 

An APT may be an appropriate asset protection tool for (1) professionals at high risk of litigation (physicians, engineers, architects, etc.); (2) couples seeking an alternative to a prenuptial agreement; (3) people wanting to protect a nest egg; and (4) people who are vulnerable to financial scams.