6 ABR 412
UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA
In re RAEJEAN BONHAM, aka Jean
Bonham, aka Jeannie Bonham, dba
World Plus; WORLD PLUS, INC., an
Alaska corporation; and, ATLANTIC
PACIFIC FUNDING CORP., a Nevada
corporation,
Debtor(s) |
Case No. F95-00897-HAR
In Chapter 7
|
In re BONHAM RECOVERY ACTIONS,
a proceeding to jointly administer
certain pre-trial issues in numerous
related adversary proceedings.
|
ADV PROC NO F95-00897-168-HAR
(BANCAP No. 96-4281)
MEMORANDUM DECISION
DETERMINING THAT THE TRUSTEE
HAS ESTABLISHED THAT DEBTORS
OPERATED A PONZI SCHEME FROM
1989
|
6 ABR 413
1. INTRODUCTION- The debtors operated a business from 1984, by
RaeJean Bonham first, and by all three later on, selling airline tickets procured by
debtors using frequent flier miles purchased from brokers. Ticket revenues declined
steadily from 1988 until an involuntary bankruptcy shut debtors down in December
1995. The business never generated a profit after 1988.
From 1988, the debtors procured numerous investors at an increasing rate,
ostensibly to finance the ticket business, but whose investments were used almost
exclusively to pay off earlier investors at exorbitant interest rates.
The trustee filed a number of fraudulent transfer actions seeking to recover
money paid by the debtors to investors.(1)
He has moved for summary judgment(2) to
establish, among other things, that the debtors operated a Ponzi scheme from at least
December 1989.
Some defendants oppose the motion to establish the existence of a Ponzi
scheme. They argue that the losses debtors suffered may just as well have resulted
from debtors having bled the funds from operations of a profitable ticket business.
I conclude that the trustee has established the existence of a Ponzi scheme
through a meticulous reconstruction of the debtors' disarrayed records.
6 ABR 414
Though the defendants' expert points to a number of alleged fallacies in the trustee's analysis, most
are quibbling, inconsequential, or speculative. The one significant discrepancy is due to
the expert's misinterpretation of undisputed facts - such that his expert opinion should
be excluded under the court's Daubert(3) gatekeeper function as having no factual basis.
The following chart(4) graphically shows the existence of a Ponzi scheme
from at least December 1989, expanded exponentially:
That is the picture of a Ponzi scheme.
6 ABR 415
2. FACTUAL AND PROCEDURAL BACKGROUND-
2.1. General Overview- This Memorandum is about whether the trustee
has established that the debtors operated a Ponzi scheme for the six-year period before
this bankruptcy case began on December 19, 1995. Thus, we must look back to the
end of 1989.
A Ponzi scheme was described by the 9th Circuit Court of Appeals
as:(5)
. . . an arrangement whereby an enterprise makes payments to
investors from the proceeds of a later investment rather than
from profits of the underlying business venture, as the
investors expected. The fraud consists of transferring
proceeds received from the new investors to previous
investors, thereby giving other investors the impression that a
legitimate profit making business opportunity exists, where in
fact no such opportunity exists.
RaeJean Bonham, and her closely held corporations, World Plus, Inc. and
Atlantic Pacific Funding Corp., operated an airline ticket business - Bonham from 1984,
World Plus, Inc. from 1991, and Atlantic Pacific Funding Corp. from 1992 - to
December 1995, when a bankruptcy petition was filed. Ostensibly, to fund the travel
business, debtors borrowed money, mostly from individuals on a relatively short-term
basis, while offering extremely high interest. This borrowing began by Bonham in
August 1988. I have described the debtors' operations in great detail in a published
opinion regarding the issue of substantive consolidation.(6)
The trustee filed a number of adversary proceedings to avoid fraudulent
6 ABR 416
transfers allegedly made to investors. He has moved for summary judgment to
establish, among other things, that the debtors operated a Ponzi scheme.
(7) Although
there are numerous declarations and depositions of non-experts submitted by the parties
on the Ponzi scheme issue, none delve into the financial details in depth or with rigor.
This is principally a battle of experts.
At the oral argument on the trustee's motion, I announced my decision that
the trustee had prevailed in establishing the factual existence of a Ponzi scheme and
would not have to litigate that issue at trial. I have entered final judgments in a number
of individual BRA adversary proceedings based on that oral ruling. There are some
adversary proceedings which have since been withdrawn to U.S. District Court, and a
number still pending in the U.S. Bankruptcy Court. This Memorandum is for the benefit
of those proceedings remaining in the bankruptcy court.
In his summary judgment motion, the trustee alleges that the debtors were
paying earlier investors with the proceeds from later investors in a business climate
which was not generating sufficient income and profit to pay the investors anything at
all from the ticket business.
The debtors did not keep books of account which complied with the
requirements of good accounting practice, let alone generally accepted accounting
principles. Bonham commingled funds between the two corporations and herself
indiscriminately. The usual periodic financial statements in the form of balance sheets,
income statements, or orderly cash receipt and disbursement journals, do not exist. In
addition, Ms. Bonham has not cooperated with the trustee by promptly turning over to
him what records she had. Nonetheless, the trustee has meticu-
6 ABR 417
lously reviewed, assembled, and analyzed the records to recreate the contours of the debtors' business
operations from 1988 through the date of the bankruptcy petition.
From the records, the trustee and his expert witness, E. Jayne MacPhee,
have reconstructed the operations by recasting the financial history into more familiar
financial statements, such as income statements. They have broken the business into
two parts for analysis - one to isolate the operations of the ticket sale business, and the
second to analyze the "investment" part of the business - to determine what patterns
can be derived about how the debtors borrowed money through investment contracts
and paid those contracts back throughout the six-year period and whether the ticket
business carried itself.
The trustee concludes that the ticket sale business, based on the debtors
selling tickets procured by purchase of frequent flyer mileage (almost exclusively on
Delta Air Lines), was a money-losing front - a sham - to entice investors with the
facade of legitimacy. He also concludes that money from new investors was used
exclusively to pay old investors in a classic Ponzi scheme.
The defendants retained their own expert, F. Wayne Elggren, a CPA, a
bankruptcy trustee, an insolvency accountant, and a fraud investigator with substantial
experience and impressive qualifications and credentials. While the defendants question
the expertise of the trustee and MacPhee, because of their lesser credentials and
experience, the trustee has not questioned the qualifications of Elggren.
6 ABR 418
Mr. Elggren found numerous faults with the methodology and analysis of
the trustee and MacPhee. Elggren concludes in a general way that there is too much
unaccounted for cash and profits from the ticket business to say it was a sham.
He relies heavily on a "smoking gun" in the form of some testimony,
pleadings and orders in the case alluding to $9,000,000 in ticket revenues - MacPhee
came up with only $6,000,000 and the trustee, $4,800,000. He has, however,
misunderstood or been misadvised about the context in which the $9,000,000 ticket
revenue figure came up in the main case - in the course of a settlement involving the
amount of Delta Air Lines' claim - and he is hoisted on his own petard when he uses it
to analyze the debtors' business history.
The balance of his criticisms are of such small size or consequence, or so
speculative or inclusive, that they are akin to straining at gnats.
2.2. Overview of Debtors' Record Keeping System For the Ticket
Business-(8) The debtors sold airline tickets, principally on Delta Air Lines, through
storefront offices in Fairbanks and Wasilla. The airline tickets were generally procured
using frequent flyer miles purchased from brokers of those miles.
6 ABR 419
The rudimentary record keeping system used by the debtors consisted of
index cards listed alphabetically by customer. Stapled to these cards were receipts
showing the amount paid by the customer and the balance owing.
The debtors also maintained reservation cards for each reservation by a
customer. The reservation cards were primarily used to keep track of customers until
the customer had traveled; they were kept in a "to-be-ordered" file until the tickets were
purchased, usually shortly before the date of travel. After the customer traveled, they
were placed in a "dead" file indicating that the transaction was completed. These dead
files were arranged alphabetically also.
Money paid at the time of the reservation was generally entered into a
deposit log or daily receipt log, from which bank deposit slips were usually created.
Occasionally, cash receipts were not recorded in the logs. The trustee has located daily
receipts for July-December 1990, and 1994, only.
The debtors kept track of the ticket sales in "broker books." There is one
for each vendor of frequent flyer miles. There appears to have been five or six principal
ones, although she may have used as many as fifty-one over the course of the business.
In the broker book for the particular broker from whom frequent flier miles was being
purchased, Ms. Bonham would record the name of the customer, destination, and
airline.
She created monthly summary sheets from the broker books. From these
sheets, Bonham prepared a list of customers that flew that month, the ticket price, the
cost of the ticket, and the difference. These reflect the cost of goods sold and gross
profit. Unlike financial records kept in accordance with good
6 ABR 420
accounting practice, debtors' records did not exactly match up income and expenses in the same accounting
periods. The summary sheets were collected in what Ms. Bonham referred to, in a pre-bankruptcy deposition with Delta Air Lines, as the "Red Binders."
The trustee and his staff physically counted the number of round-trip
tickets sold as disclosed in the Red Binders for 1988-1992, 1994, and January 1995,
and came up with 9,350.
Not all the summary sheets and accompanying broker books were located.
The trustee located these documents for 1988 through 1992, 1994, and for January
1995.(9)
2.3. The Trustee's Analysis
in Detail-RaeJean Bonham began selling
tickets in 1984.(10) In 1987 or early 1988, she moved to an office in the Northward
Building in Fairbanks, and changed her business name to World Plus, which was a sole
proprietorship.(11)
She was not a full-service travel agent, but only sold airline tickets procured
with frequent flier miles.(12) She had only a few full time employees at any
6 ABR 421
one time,(13)
and employed her daughter, Stephanie, from time-to-time on a part-time basis.
(14)
Tickets were generally procured by World Plus for its customers by calling
Delta Air Lines directly, although other carriers were sometimes used. The customer
usually paid for the ticket in advance, typically about $550 for a round-trip coach ticket
from Fairbanks. Because operations like the debtors' were being monitored with
progressive intensity by the airlines which felt the sale of frequent flyer miles or the use
of sold miles was against airline policy, Bonham took pains to hide from the airlines the
fact that she was acquiring tickets with purchased frequent flyer miles.
Bonham began issuing investment contracts in August 1988. She, World
Plus, Inc., and Atlantic Pacific Funding Corp., collectively issued more than 7,000
contracts up to the time of the bankruptcy petition in the form of crude promissory
notes.(15) Ms. Bonham began by
offering 50% interest for 60 working days.(16) The
interest rate was reduced to 50% every 8 months, and then 20% every 6 months. In
late 1995, shortly before the business collapsed, debtors offered a rate as high as 50%
interest in 3 months, and ultimately within 10 days.
6 ABR 422
Investors were told that the interest was available due to the success of
the ticket sale business. Bonham indicated debtors purchased blocks of frequent flyer
mileage from Fortune 500 companies such as IBM, Apple, Sony, Magnavox, Hewlett
Packard, and Xerox, which she then sold at a substantial markup.
(17) The sales pitch
about purchasing miles from Fortune 500 corporations was untrue.
(18) Bonham obtained
all her tickets from wholesale frequent flyer ticket brokers.
When the investment contracts were due, investors would either roll their
investments over into a new contract or be paid according to their terms, or use some
combination of the two. Bonham routinely encouraged investors to roll over maturing
contracts into new ones.(19)
To keep track of and organize the large number of documents, the trustee
developed a database with Quicken software. He input, to the extent that records were
available, most of the pertinent financial transactions the debtors were involved in for
which he could obtain a record. These included inputting information from bank
accounts, deposits, checks, broker books and summaries, and investment contracts.
The trustee did not attempt to input from the index cards the details regarding each
customer's travel.
6 ABR 423
From the database, the trustee summarized the information about the
investment contracts. With roll overs of maturing investment contracts and ever-expanding new contracts, the investment contracts outstanding from 1988 through
1995 are shown in the following table, prepared by the trustee's expert, Jayne
MacPhee:(20)
| Year | Outstanding Investment
Contracts at Year End |
| 1988 | $174,195.00 |
| 1989 | $746,294.00 |
| 1990 | $1,907,280.00 |
| 1991 | $4,133,296.00 |
| 1992 | $8,141,462.00 |
| 1993 | $15,687,067.00 |
| 1994 | $28,341,301.00 |
| 1995 | $50,510,618.00 |
The trustee also constructed financial statements for the debtors with the
aid of the Quicken database in order to determine the profitability of the debtors' ticket
business. The lack of some records hindered this process, but the trustee has, where
necessary, subpoenaed bank records to fill in the gaps as best he could.
(21)
The trustee has essentially retrieved complete deposit detail, i.e., the
source and purpose of funds deposited into the debtors' accounts, for every year
6 ABR 424
except 1989, though some detail is lacking for 1990.(22) The trustee was also able to identify
the debtors' disbursements by obtaining copies of canceled checks, and where
necessary, additional supporting documents related to wire transfers and purchases of
cashier checks. The database is reconciled to the debtors' bank statements.
MacPhee tested the database in order to verify its accuracy. She confirmed
that the database reconciled to the bank statements, and she constructed two random
samples and tested the source documentation to the input data.
(23) MacPhee concluded
that the trustee's categorizations of deposits and disbursements were proper, though
due to the insufficient deposit detail for 1989 and part of 1990, the amount of
unallocated deposits rendered the deposit allocation in the Quicken database unreliable
for purposes of her analysis.(24)
Both sides agree that any analysis of the debtors' finances and profitability
depend on a determination of their gross revenues and the appropriate costs of the
ticket business. The parties reach differing figures for both the debtors' gross revenues
and the costs of tickets. The following summarizes the trustee's methodology.
Gross Revenue; Cost of Costs Sold Gross Margin - MacPhee calculated the
debtors' gross revenues by dividing the cost of debtors' purchases from frequent
6 ABR 425
flyer mileage brokers (costs of goods sold) by the debtors' gross margin percentage.
(25) She
relied upon the cost of frequent flyer miles purchased as identified in the Quicken
database as the most reliable source of information in this case.
(26) She based this on the
fact that most of the frequent flyer mileage brokers were located out of state, and the
debtor routinely paid her suppliers by check. Also, ticket purchasers generally paid
debtors in advance so there should have been little inventory of frequent flyer miles to
account for.
MacPhee attempted to be conservative in her analysis to the benefit of the
defendants. She points out that the amount of purchases of frequent flyer miles
identified in the records that debtors turned over is lower than the larger amount
identified in the Quicken database, and the debtors' records do not cover all the
applicable years. The following table summarizes the cost of goods sold (COGS) figures
used by MacPhee in her analysis:(27)
6 ABR 426
Comparison of Ticket Purchases Per Quicken vs Debtors' Bank Accounts
| Year |
Ticket COGS [Per Bank Records, First Compton Affidavit,
Exhibit 13] |
Ticket COGS
[Per Debtors' Business Records,First MacPhee Affidavit,
Exhibit D] |
Amount by Which Bank Records Exceed Debtors' Business Records |
Percentage by Which
Bank Records Exceed Debtors' Business Records |
| 1988 |
1,169,751.00 |
1,138,345.00 |
31,406.00 |
3% |
| 1989 |
885,623.00 |
833,135.00 |
52,488.00 |
6% |
| 1990 |
900,651.00 |
790,825.00 |
109,826.00 |
12% |
| 1991 |
713,888.00 |
581,833.00 |
132,055.00 |
12% |
| 1992 |
710,076.00 |
670,630.00 |
39,446.00 |
18% |
| 1993 |
546,395.00 |
524,049.00 |
22,346.00 |
4% |
| 1994 |
377,718.00 |
377,559.00 |
159.00 |
0% |
| 1995 |
145,476.00 |
N/A |
N/A |
N/A |
| Totals |
5,449,578.00 |
4,916,376.00 |
533,202.00 |
8% |
To arrive at gross revenues from ticket sales, MacPhee divided the cost of
the frequent flyer miles purchased by the gross margin percentage (the markup debtors
made on their ticket sales) to determine the debtors' annual ticket sales.
(28) The gross
profit percentage was determined on an annual basis by averaging the ticket sales
identified in the debtors' records.(29) The monthly summaries contain the debtors' cost of
the ticket, the sales price, and the resulting net gain or loss, which is totaled on a
monthly basis.
For those years for which no monthly summaries were available, MacPhee
averaged the prior and subsequent year. The effect of this approach is
6 ABR 427
to increase the debtors' ticket revenue as compared to that reported in the debtors' records. A
summary of MacPhee's calculation of debtors' gross margin percentage is shown in the
following table (which excludes the year the business crashed, in 1995):
(30)
MacPhee's Calculation of Gross Margins
| Year |
Gross Ticket Sales per Business Records |
COGS per Business Records |
Gross Profit Before G&A per Debtors' Business Records |
Gross Profit Percentage |
| 1988 |
$1,227,825.00 |
$1,138,345.00 |
$89,480.00 |
7.29% |
| 1989 |
$ 856,744.00 |
$ 833,135.00 |
$ 23,609.00 |
2.76% |
| 1990 |
$ 854,431.00 |
$ 790,825.00 |
$ 63,606.00 |
7.44% |
| 1991 |
$ 680,995.00 |
$ 581,833.00 |
$ 99,162.00 |
14.56% |
| 1992 |
$ 786,676.00 |
$ 670,630.00 |
$ 116,046.00 |
14.75% |
| 1993 |
$ 620,311.00 |
$ 524,049.00 |
$ 96,217.00
(estimates, as 1993
records not available) |
15.51% |
| 1994 |
$ 453,948.00 |
$ 377,559.00 |
$76,385.00 |
16.83% |
Debtors' Operating Costs, Owner's Draws, and Credit Card Payments - The
parties also disagree as to calculation of the debtors' operating costs. MacPhee
subtracted the operating expenses as set forth by the trustee in the Quicken database
from gross profits (i.e., ticket sales derived from COGS, minus COGS) to arrive at net
profit from the ticket business. The trustee identified each operating expense by check
number, amount, payee, and the date the check cleared the
6 ABR 428
debtors' account.(31)
MacPhee also deducted the debtors' payments made for personal expenses.
(32)
Numerous payments were made for the Bonham's personal benefit, or the
benefit of her family, including trips, purchases of cars, heavy equipment for her
husband's business, and payments on behalf of her son and daughter.
(33) The trustee
categorized these payments as "Owner's Draws" in the database.
(34)
Additionally, the debtor had significant credit card expenses which were
predominantly for personal use, but also included business expenses such as direct
purchases of tickets from traditional airline carriers. The trustee did not itemize the
individual credit card charges, but aggregated the credit card payments in the category
"Credit Cards" in the database.(35)
Using MacPhee's analysis (revised to reflect those items identified by the
defendants in Defendants' Memorandum) the debtors' ticket business made a net profit
only for 1988, but failed to cover its operating expenses thereafter. Her calculations are
shown in the following table:(36)
6 ABR 429
Debtors' Profit (Loss) from the Ticket Business Alone
| Year |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
| Ticket Revenue |
1,261,731 |
913,855 |
1,017,706 |
821,477 |
832,934 |
646,698 |
452,559 |
262,416 |
| Ticket COGS |
1,169,751 |
888,632 |
931,710 |
701,077 |
710,077 |
546,395 |
377,393 |
218,251 |
| G & A Expenses |
33,129 |
64,633 |
111,147 |
134,152 |
151,199 |
177,927 |
157,726 |
68,687 |
| Net Profit (Loss) |
58,851 |
(39,410) |
(25,151) |
(13,752) |
(28,342) |
(77,624) |
(82,560) |
(24,522) |
Considering the debtors' personal expenses included in the "Owner's Draws" and
"Credit Cards" categories, the ticket business shows significant losses for every year
including 1988, as shown in the following table:(37)
6 ABR 430
Debtors' Profit (Loss) From Ticket Operations
| Year |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
| TicketRevenue |
1,261,731 |
913,855 |
1,017,706 |
821,477 |
832,934 |
646,698 |
452,559 |
262,416 |
| Ticket COGS |
1,169,751 |
888,632 |
931,710 |
701,788 |
710,077 |
546,395 |
377,393 |
218,251 |
| G & A Expenses (First Compton Affidavit,
(38)Exhibit 13) |
33,129 |
64,633 |
111,147 |
134,152 |
151,199 |
177,927 |
157,726 |
68,687 |
| Owner's Draws (First Compton Affidavit, Exhibit 15) |
103,031 |
167,957 |
142,558 |
116,525 |
160,807 |
144,918 |
73,043 |
36,031 |
| Credit Cards (First Compton Affidavit, Exhibit 17) |
17,397 |
38,701 |
72,238 |
86,088 |
90,608 |
119,213 |
88,662 |
77,159 |
| Net Profit (Loss) from Travel Operations |
(61,577) |
(246,068) |
(239,947) |
(217,076) |
(279,757) |
(341,755) |
(244,265) |
(137,712) |
Using the total deposits in the Quicken database, MacPhee also quantified
the debtors' investment-related deposits and disbursements. Because the debtor had
only two sources of revenue, the sale tickets and the issuance of investment contracts,
all non-ticket revenues were investment deposits. The trustee did not, however,
arbitrarily place deposits in the investment category which obviously do not belong
there. For example, deposits that, by virtue of their odd amount, did not look like they
were to purchase investment contracts were generally considered travel income.
6 ABR 431
MacPhee reconciled her figures with the Quicken database by
conservatively (i.e., favorably to the defendants) characterizing most of the unallocated
income as ticket income.(39) Defendants have not presented any evidence or otherwise
specifically challenged MacPhee's allocations except to argue that it overstates
investments and understates the ticket business.
While ticket revenues fell steadily from $1,261,731 in 1989, to $262,416
in 1995, the investment aspect of debtors' operation assumed greater and greater
importance until it amounted to over 98% of her entire cash flow, measured by revenue.
The following two tables compare the ticket revenue to the investment operations. The
first was compiled by MacPhee,(40) using $177,043 for 1995, and the second using
$262,416 as well as other adjustments claimed by defendants to more accurately
reflect debtors' business:
6 ABR 432
Investment Deposits as a Percentage of Total Revenue
| Year |
Travel Revenue |
Investment Revenue |
Total Deposits |
| Dollars |
Percent of total |
Dollars |
Percent of total |
| 1988 |
$1,261,731 |
84% |
$232,343 |
16% |
$1,494,074 |
| 1989 |
$910,760 |
53% |
$803,573 |
47% |
$1,714,333 |
| 1990 |
$973,046 |
42% |
$1,353,306 |
58% |
$2,326,352 |
| 1991 |
$821,381 |
25% |
$2,406,530 |
74% |
$3,227,911 |
| 1992 |
$832,934 |
17% |
$4,205,760 |
83% |
$5,038,694 |
| 1993 |
$646,698 |
7% |
$8,233,308 |
93% |
$8,880,006 |
| 1994 |
$442,008 |
4% |
$9,821,407 |
96% |
$10,263,415 |
| 1995 |
$177,043 |
1% |
$15,029,265 |
99% |
$15,206,308 |
| Total |
$6,065,601 |
13% |
$42,085,492 |
87% |
$48,151,093 |
Incorporating the errors noted by the Elggren report, the result is
substantially the same as shown in the following table (the shaded areas show the
changes from the previous table; there is only a 2% change favorable to defendants in
1990 and 1% in 1995):
6 ABR 433
Investment Deposits as a Percentage of Total Revenue
[Adjusted for Alleged Errors Noted by Defendants]
| Year |
Travel Revenue |
Investment Revenue |
Total Deposits |
| Dollars |
Percent of total |
Dollars |
Percent of total |
| 1988 |
$1,261,731 |
84% |
$232,343 |
16% |
$1,494,074 |
| 1989 |
$913,855 |
53% |
$800,478 |
47% |
$1,714,333 |
| 1990 |
$1,017,706 |
44% |
$1,308,646 |
56% |
$2,326,352 |
| 1991 |
$821,477 |
25% |
$2,406,434 |
75% |
$3,227,911 |
| 1992 |
$832,934 |
17% |
$4,205,760 |
83% |
$5,038,694 |
| 1993 |
$646,698 |
7% |
$8,233,308 |
93% |
$8,880,006 |
| 1994 |
$452,559 |
4% |
$9,810,856 |
96% |
$10,263,415 |
| 1995 |
$262,416 |
2% |
$14,943,892 |
98% |
$15,206,308 |
| Totals |
$6,209,376 |
13% |
$41,941,717 |
87% |
$48,151,093 |
Comparing the relatively modest ticket revenue to the enormous accruing
unpaid investment interest dramatically shows the fallacy of defendants' claim that
debtors were conducting a profitable ticket business. Even ignoring operating expenses,
credit cards, and owner's draws, the debtors' ticket operation never came close to
covering the interest that was accruing on debtors' investment contracts as shown in
the following table (in which the operating expenses and owner's draws are shaded):
6 ABR 434
Ticket Revenue and Profitability Compared to Interest Accrual (in Thousands)
| Year |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
| Gross Ticket Profit, (i.e., before G&A Expenses)
(41) |
92 |
25 |
86 |
120 |
122 |
100 |
75 |
44 |
| Net Profit (Loss) from Travel Operations
(42) |
(62) |
(246) |
(239) |
(217) |
(279) |
(341) |
(247) |
(137) |
| Accrued Interest Expense(43) |
(159) |
(719) |
(1,826) |
(3,962) |
(7,937) |
(15,430) |
(28,272) |
(50,519) |
Balance Sheet - MacPhee's analysis shows that the debtors were
continuously insolvent from 1988 through 1995, as shown in the following table:
(44)
Debtors' Summarized Balance Sheet
(Amounts Are In Thousands)
| Year |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
| Assets |
15 |
27 |
82 |
171 |
205 |
258 |
69 |
(9) |
| Liabilities |
174 |
746 |
1,907 |
4,113 |
8,141 |
15,687 |
28,341 |
50,510 |
| Net Worth |
(159) |
(719) |
(1,826) |
(3,962) |
(7,937) |
(15,430) |
(28,272) |
(50,519) |
2.4. The Analysis of Defendants' Expert Wayne Elggren, and the Trustee's
Rebuttal- I will summarize the analysis of defendants' expert, Wayne Elggren, and the
trustee's responses.
6 ABR 435
Flaws in Trustee's Analysis and Failure to Account for Overall Ticket
Volume/Ticket Sales(45) - The central thesis of Wayne Elggren's criticism of the
methodology of the trustee and MacPhee is that they went about the analysis
incorrectly, and that they failed to explain $2-3,000,000 of potential ticket revenue.
Elggren believes that in a proceeding in the main case regarding a settlement of the
Delta Air Lines' claim, it was established and accepted by the court that the debtors'
business generated at least $9,000,000 in Delta Air Lines' ticket revenues.
Elggren theorizes the possibility of $1,500,000 gross profits (sufficient to
pay much of the general and administrative expenses), and compares it to MacPhee's
calculations as follows:
| |
1988-1995 per Elggren |
1988-1995 per MacPhee |
| Ticket Sales |
9,000,000 |
100.00% |
6,065,601 |
100.00% |
| Less: Cost of Tickets Sold |
7,500,000 |
83.33% |
5,429,151 |
89.50% |
| Gross Margin |
1,500,000 |
16.67% |
636,451 |
10.50% |
The trustee responds that Mr. Elggren has misinterpreted the import of the
hearing on July 28, 1997, in the Bonham main case involving the settlement of the
Delta Air Lines' proof of claim. The court was personally involved and agrees that the
$9,000,000 figure bandied about at that hearing was an artificial one generated by
Delta to illustrate how much damages would be awarded by the U.S. District Court in
Georgia under applicable case law regarding the "stowaway doctrine." Under that
doctrine, Delta claimed it was entitled to damages based on the debtors' misuse of
frequent flyer miles to reimburse Delta the entire cost of a
6 ABR 436
one-way ticket at the lowest
rate available at the time. Delta argued that, conservatively and considering only a one-way trip
from Fairbanks or Anchorage to Seattle at the lowest rate, damages of about
$9,000,000 would be generated.
This figure was arrived at by Delta's analysis of the reservation cards in
which it had determined that there were about 19,906 one-way trips at about $456.84
per ticket.(46) The trustee contends that most people travel on a round-trip fare. The
trustee had counted about 9,350 tickets, which is within about 600 of the 9,953
(turning Delta's one-way trips into round-trips). In fact, the trustee's calculations about
the number of tickets is amazingly close to Delta's.
There is no "$9,000,000 in ticket revenue" which has been acknowledged
in this case, either by the trustee or the court.
The defendants, nonetheless, used the $9,000,000 figure and estimated
that the cost of tickets sold was 83.33% of the gross ticket sales. The cost-of-tickets-sold figure was derived not from Ms. Bonham's records, but through the cursory
affidavit of Bryan Wilson, the office manager at Discount World Travel, from 1986-1989. Discount had itself sold frequent flyer mileage before it quit in 1989. There is no
indication that Mr. Elggren actually looked at the books of Discount.
Elggren also criticized MacPhee's gross ticket sales figure of $6,065,601
on the basis that she used improper methodology. He said she should have added up all
the reservation cards to arrive at a more reliable ticket income
6 ABR 437
figure, but did not himself attempt to do so, either for all the reservation cards or by
some method of sampling.
Elggren argues that MacPhee and the trustee ignored material evidence of
significant cash transactions.(47) He does this based on the following:
- RaeJean Bonham's daughter, Stephanie, who worked in the
business, said that approximately one-half of the ticket transactions
were paid in cash and the other half paid by check. This indicates to
Elggren that some of the cash may never have made it to a bank
account.(48)
- Elggren gives four examples of mischaracterizations of cash
transactions totaling $14,705 by the court's calculation
(49) (although
the trustee calculates these to total $16,280).(50)
The trustee responded that he has accounted for over $5,000,000 in cash
deposits, about $2,000,000 for ticket sales and the rest in unallocated cash deposits.
(51)
Also, the trustee notes that MacPhee's principal methodology in reconstructing the
operations used the cost of the ticket sales (i.e., adding up the payments the debtors
made to ticket brokers), which does not rely on the individual deposits of purchasers,
cash or otherwise. The trustee points out that, under the
6 ABR 438
percentage markup method,
the amount of ticket revenue calculated (whether you use MacPhee's percentage
markup or Elggren's 83.33% COGS) is not effected by Ms. Bonham's use of cash.
MacPhee's suggests that the best method of determining gross sales is to
find out what the debtors paid to ticket brokers to purchase the tickets that they sold to
customers. She reasoned that this was one of the most reliable figures for analyzing the
debtors' operations because it was derivable from debtors' checks and broker
summaries. Also, since the tickets were generally paid for in advance by the customers,
and not ordered until just before needed from brokers, there would be little inventory to
account for. Using cost-of-tickets-sold percentages derived from debtors' own broker
summaries, she arrived at a cost of goods sold of $5,429,151 and an average 89.50%
COGS.
Even using Elggren's unsupported 83.33% gross margin percentage to
derive gross sales, the ticket sales would only have been increased by an amount of
little less than $500,000, or $6,515,242. This still leaves the ticket business woefully
under water. Conversely, using the $9,000,000 suggested by Elggren, and the 89.50%
average gross profit percentage derived from debtors' records by MacPhee, the gross
margin is only $945,000, instead of the $1,500,000 suggested by Elggren. The
following table may make this more understandable (using Elggren's $9,000,000 gross
ticket revenue, MacPhee's COGS, and applying the gross profit percentage to each as
found by the other party):
6 ABR 439
| |
1988-1995 (Income per Elggren; Gross Margin Percentage per MacPhee) |
1988-1995 (Gross Margin Percentage per Elggren, COGS per MacPhee) |
| Ticket Sales |
9,000,000 |
100.00% |
6,515,242 |
100.00% |
| Less: Cost of Tickets Sold |
8,055,000 |
89.50% |
5,429,151 |
83.33% |
| Gross Margin |
945,000 |
10.50% |
1,086,091 |
16.67% |
Compare this to Elggren's hypothesis as shown again in the following
table:(52)
| |
1988-1995 per Elggren |
1988-1995 per MacPhee |
| Ticket Sales |
9,000,000 |
100.00% |
6,065,601 |
100.00% |
| Less: Cost of Tickets Sold |
7,500,000 |
83.33% |
5,429,151 |
89.50% |
| Gross Margin |
1,500,000 |
16.67% |
636,451 |
10.50% |
Elggren argues that "the reservation cards could have been a more
complete source of information to evaluate ticket sales."
(53) He also argues that the
trustee should have gotten information about the frequent flyer mileage purchases from
the fifty-one mileage brokers.(54)
Elggren, himself, did not attempt to extract the information or analyze the
data from the reservation cards to demonstrate that MacPhee's calculations are grossly
inaccurate. Nor, has he questioned the accuracy of the cost of tickets (i.e., the cost of
buying frequent flyer miles from brokers), except to say the trustee should have
attempted to get information from the brokers directly. The defendants
6 ABR 440
listed some of the brokers as potential deponents in the BRA case management proceedings to prepare
for defending against the summary judgment. Apparently, the defendants were
unsuccessful in getting this information from the brokers themselves, so they are hard
put to criticize the trustee for not doing so.
Failure to Recognize Credit Card Transactions - Elggren states that RaeJean
Bonham used credit cards to purchase airline tickets "from various discount ticket
brokers."(55) Elggren identified $21,647.18 in ticket purchases made with debtors' credit
cards. The trustee explained that these were not purchased from frequent flyer ticket
brokers, but were credit card purchases made with regular airlines such as Northwest or
Alaska Airlines, and appear to be for the use of herself and her friends over an eight-year
period.(56)
Failure to Reconcile to Reservation Cards(57) - Elggren again alludes to the
fact that at another time in this case the trustee, using principally the debtors' broker
books and summaries instead of the individual reservation and/or index cards, came up
with approximately 9,350 tickets. Elggren suggests there is a "discrepancy" because
Delta Air Lines, in its analysis of the debtors' operations, came up with an estimate of
19,906 tickets, and even James DeWitt, an attorney for the trustee, calculated the
number of tickets sold to be 18,500.
This has been previously discussed in this Memorandum. The 19,906 or
18,500 are hypothetical one-way trips for the purposes of calculating damages
6 ABR 441
under the stowaway doctrine, and not the more usual round-trips, which would generate half
the figure that Delta or Mr. DeWitt arrived at. Essentially, the number of actual tickets
arrived at by Delta, DeWitt, and Compton, are very close.
Failure to Include Wasilla Records(58) - Elggren claims that MacPhee failed to
account for ticket sales in the Wasilla office. The trustee has countered that those sales
are included in the Quicken database and that there was no separate bank account for
the Wasilla office. Secondly, even if Wasilla had been missed, there is no indication that
frequent flyer miles were purchased out of the Wasilla location, and MacPhee has
accounted for all frequent flyer miles purchased from brokers and used that figure to
arrive at a gross sales figure.
Failure to Include All World Plus Transactions
(59) - Elggren argues that the
trustee has omitted a bank account, and mentions some checks for the time period
between September 1987 and January 1988.
The trustee counters that he has analyzed all checking accounts, going to
banks when he could not find bank statements or deposit detail elsewhere to get copies
of the checking and deposit information. The checking account that Elggren identifies
was located at the First National Bank of Fairbanks, East College Branch, had a balance
of about $300 in March 1989, and was never substantially used after that. As such, it
has little bearing on the issue of whether debtors conducted a Ponzi scheme from
December 19, 1989, through December 19, 1995.
6 ABR 442
Failure to Properly Allocate and Identify Deposits
(60) - Elggren says that a
little over $1,100,000 of deposits for the year 1989 were unallocated.
The trustee responds that those allocation figures were indeed provided to
defendants' counsel after the trustee's motion was filed.
(61)
Failure to Properly Allocate General and Administrative Expenses
(62) -
Elggren criticizes the trustee for not allocating general and administrative expenses
between the "travel business" and the "investment business."
The trustee responds that, although the investment activity of the debtors
was broken out for analysis purposes, there was no separate "investment business" as
such. There was only the business of selling airline tickets; the procurement of funds
through investment contracts was supposedly an adjunct to carrying on that business.
All the general and administrative expenses are properly charged to travel business to
determine if that aspect of the business ever made money doing what it claimed to do,
selling tickets.
In addition, the trustee has shown by yearly analysis how the business
failed to make a profit each year from 1989, until it closed in December 1995. For the
purposes of the fraudulent conveyance actions, the trustee only seeks to recover
transfers that occurred no earlier than about December 19, 1989. By analyzing the
business from 1988, and showing the increase in investment contracts from their
inception that year, the trustee has established that the business of selling tickets
6 ABR 443
was losing money at an accelerating rate while investment contracts increased exponentially.
Failure to Properly Allocate Owner's Draws>(63) - Elggren argues that these
are improperly handled from a financial accounting perspective and that the draws
should have more properly been allocated to dividends, which do not impact the profit
and loss statement. Secondly, he said that, even if properly expensed, they should have
been allocated between the travel business and the investment business.
The trustee responds again that there were not separate businesses, and
that allocation between investment and travel is not required. The trustee notes that the
inference to be drawn from the debtors' free use of funds over the years when the
ticket operation was barely making a gross profit is indicative of the debtors' intent to
hinder, defraud, and delay by operating a Ponzi scheme. This money had to come from
investment contracts and not the ticket business.
Changes in MacPhee Reports(64) - Elggren criticizes MacPhee for changes in
her report of June 1998, from the original report in December 1997. The changes are:
| Report Date |
Ticket Income |
Investment Deposits |
Total Deposits |
| June 8, 1998 |
$6,065,604 |
$42,085,492 |
$48,151,096 |
| December 7, 1997 |
$6,089,769 |
$41,853,848 |
$47,943,617 |
| Difference |
($24,165) |
$231,644 |
$207,479 |
6 ABR 444
In addition, Elggren indicates that MacPhee was able to identify an
additional $1,642,187 previously unidentified. MacPhee was apparently refining her
analysis with updated data. Elggren does not explain the material significance of his
criticism of the less than ½% variations he has unearthed.
Assumed "Ponzi" Scheme(65) - Elggren criticizes the trustee for jumping to
the conclusion that there was a Ponzi scheme from the inception of World Plus in 1988.
He says that the trustee has on numerous occasions improperly categorized transactions
negatively impacting the travel operations. Other factors that he finds militate against
the finding of a "Ponzi" scheme are:
- Unlike a classic "Ponzi" scheme in which there is no underlying
business enterprise, only investor money changing hands, World Plus
operated an income-producing airline ticket business. Apart from use
of new investor funds to pay returns to old investors, the most
distinctive characteristic of a "Ponzi" scheme is absence of a
profitable product or efforts to make profits through a productive
business enterprise.
- The approximate seven-year life span is significantly longer than the
usual three to four years or less life span of a typical Ponzi scheme.
- Most Ponzi schemes involve a network of sales agents to recruit new
investors to sustain the geometric growth; here, there is no evidence
of the use of sales agents.
- The nature of the World Plus travel business suggests that it was "in
fact, a business enterprise and not a fraudulent scheme from the outset."
6 ABR 445
Elggren contends that most Ponzi operators usually cut and run after they
hit the top and the scheme begins to collapse. He said that Ms. Bonham did not. The
trustee says she stayed and got convicted of having operated a Ponzi scheme.
Elggren also argues that an interest rate of 20% to 50% over a two- to
eight-month period, or 60% annualized, was not in and of itself indicative of a Ponzi
scheme. Elggren cites mutual funds which have had substantial rates of return, some as
high as almost 70% per year. Finally, he says that the issuance of new debt
instruments to raise money to pay off existing debt is not in and of itself indicative of a
Ponzi scheme.
MacPhee points out that in many high profile Ponzi schemes that have
reached the courts, the business has operated about as long or longer than World Plus.
For example, Chilcott Futures Fund (nine years), Hedged Investment Associates
(fourteen years); M&L Business Machine Co., Inc. (at least seven years). To which, the
court would add Bennett Funding, possibly the largest Ponzi scheme in United States
history (1990-1996, and probably several years before).(66) Many Ponzi schemes, if not
most, have some legitimate business operation, or at least the facade of one. See, for
example, Bennett Funding, Agricultural Research and Technology Group, Inc., M&L
Business Machine Co., Inc., etc.
6 ABR 446
The comparison to mutual funds which have achieved a high interest rate is
not apropos. Those mutual funds presumably did not guaranty that high of an interest
rate, which debtors contractually did in their investment contracts.
Summary and Conclusion(67) - Elggren concludes that:
- The trustee ignored relevant information.
- The trustee relied heavily on gross margin calculations in order to
arrive at estimated ticket sales, and his analysis and conclusions
depend on these calculations, which are unreliable.
- The trustee's conclusions and opinions are based on improper
methodology in that he "backed into" estimated ticket sales by
"applying gross margin analysis to ticket expense per the Quicken
database."
- The trustee miscalculated annual ticket expenses and gross margin
percentages so his estimated ticket sale figures are understated and
incorrect.
- The trustee attempted to improve the accuracy and reliability of his
estimated ticket sale figure by reallocating deposits contained within
the ticket database, but the method of reallocation appears to be
improper and arbitrary, depending only on unreliable figures.
- The trustee allocated deposits based only on his unreliable figure of
estimated ticket sales, i.e., the "estimated ticket sales" have been
turned into a "target figure" and all other reallocations are aimed at
this target or plugged figure.
-
6 ABR 447
The trustee and his attorneys have compiled the data and Quicken
database and MacPhee has not been involved with the compilation
and organization of the source data, nor in the creation of the
Quicken database.
- All of this has led to the biased conclusion that a Ponzi scheme
existed based on unreliable and biased data.
To which Elggren signed his name "under penalty of perjury" under the
name of the accounting firm Arthur Andersen & Co.
3. ISSUES- The issue to be resolved by this Memorandum is whether, for
the purposes of summary judgment, the trustee has established without substantial
controversy (i.e., so he does not have to try the facts) that the debtors operated a Ponzi
scheme with respect to their issuance of investment contracts for at least six years
before the original petition was filed.(68)
This is mostly a battle of the experts, so the court must determine whether
the trustee's experts are qualified (the trustee not having challenged Elggren's
qualification), and, even if an expert on either side is qualified, whether the court, in its
gatekeeper function, should allow the expert's testimony.
4. ANALYSIS-
4.1. The Experts Are All Qualified- The trustee does not challenge
Elggren's qualifications as an expert in forensic fraud investigation, qualified to
investigate and expertly testify to matters regarding Ponzi schemes. The defendants,
however, challenge the expertise of both MacPhee and the trustee.
6 ABR 448
The qualifications are governed by FRE 702:(69)
If scientific, technical, or other specialized knowledge
will assist the trier of fact to understand the evidence or to
determine a fact in issue, a witness qualified as an expert by
knowledge, skill, experience, training, or education, may
testify thereto in the form of an opinion or otherwise.
Accounting testimony can be the subject of expert testimony.
(70)
The defendants have focused their criticism on MacPhee's lack of a CPA
degree or certification in certain groups of accounting fraud detection professionals.
First, this seems to miss the point about the type of expert needed in this case. Few
would question that Ms. Bonham acted in a fraudulent manner in the time period closer
to December 1995. After all, she is sitting in jail for federal criminal charges where she
admitted as much in her guilty plea. The real question is when this pattern began.
The type of expertise truly needed in this case is someone who can take
poorly kept, incomplete records, involving commingled funds, and reconstruct the
business out of them. MacPhee has training in accounting matters and experience in
forensic accounting situations. She has worked as an accounting analyst reconstructing
what really happened in the M&L Business Machine case, one of the major Ponzi
schemes to reach the bankruptcy courts. Experience and training, despite the lack of a
specific degree or designation, qualify her to render an expert opinion on
6 ABR 449
accounting matters related to the reconstruction or analysis of business records, especially when a
Ponzi-type business, with commingling of funds, is suspected.(71)
While she does not have the credentials of belonging to all the professional
groups that Mr. Elggren does, she has accounting training and experience in working on
Ponzi cases, and has done an admirable job in assisting the court in understanding the
debtors' operations - a much more intellectually honest job than Mr. Elggren at that.
She qualifies as an expert in reconstructive accounting in a situation where the books
and records are incomplete and not up to standards, and the funds of the debtors are
commingled.
Likewise, the trustee, even though he is a party, may qualify as an expert,
even though his bias can be challenged.(72) He is a CPA and a panel trustee in Alaska,
which have given him on-the-job experience in understanding and reconstructing
financial transactions.
4.2. The Trial Court's Gatekeeper
Function-
Often, declarations of non-expert witnesses, offering relevant, admissible testimony, are filed in order to defeat a
summary judgment motion and controvert the declarations of the movant. The court
must not weigh the strength of the opposing parties' testimony, but should instead give
the benefit of all reasonable inferences regarding the contested facts to the nonmoving
party.(73) If there is more than a scintilla of evidence pre-
6 ABR 450
sented by the nonmovant, the
court should not decide the matter based on who presented the more compelling
affidavits; there should, instead, be a trial on the merits.(74)
But, when dealing with expert testimony in a summary judgment motion
(as well as at trial), the trial court does have the ability - indeed, the duty - to determine
if the expert testimony should be admitted in the first instance. The judge becomes the
"gatekeeper," keeping out unworthy or "junk" expert testimony. Although one of the
reasons for the gatekeeper function is to keep unworthy expert testimony from
confusing a jury, the gatekeeper function is applicable even to summary judgment
motions in non-jury cases.(75)
In the Daubert case,(76) the United States Supreme Court explained the
gatekeeper role of a federal trial judge in admitting expert scientific testimony. In the
subsequent Kumho Tire case,(77) the court clarified that Daubert applied not only to
scientific testimony, but to all expert testimony.
Daubert arose in the 9th Circuit,(78) in a case brought by the parents of two
minor children who suffered serious birth defects. The mothers took the drug Bendectin
before the children were born. It was marketed by the defendant, Merrell Dow
Pharmaceuticals (Dow).
6 ABR 451
Dow brought a motion for summary judgment supported by the affidavit of
a well-qualified physician and epidemiologist, who reviewed thirty published studies
involving 130,000 patients. In none of the studies was Bendectin found to be the cause
of the malformations suffered by the plaintiffs' children.
The plaintiffs defended against summary judgment by offering the
testimony of eight experts, each of whom had impressive credentials.
(79) These experts
determined that Bendectin could cause the birth defects based upon three types of
evidence: (a) in vitro (test tube) and in vivo (live) animal studies that found a link;
(b) pharmacological studies of the chemical structure of Bendectin showing a similarity
between the structure of Bendectin and other substances known to have caused birth
defects; and, (c) a re-analysis of the published epidemiological studies. The district
court denied admissibility of the testimony of the plaintiffs' experts.
This was upheld by the 9th Circuit Court of Appeals (citing Frye v. United
States(80)) which held that expert opinion based on a scientific technique is inadmissable
unless the technique is "generally accepted" as reliable in the scientific community.
(81)
The court held that the methodology of the plaintiffs' experts differed substantially from
the procedures accepted by recognized authorities in the field.
6 ABR 452
On appeal, the Supreme Court determined that the seventy-year-old Frye
test was no longer controlling, and that Frye had been succeeded by the legislatively
adopted Federal Rules of Evidence, and in particular, FRE 702.
(82)
The type of scientific, technical, or other specialized "knowledge" alluded
to in FRE 702:
. . . connotes more than subjective belief or unsupported
speculation. The term "applies to any body of known facts or
to any body of ideas inferred from such facts or accepted as
truths on good grounds."(83)
Basically, the court was speaking of valid scientific evidence which it referred to as
having "evidentiary reliability--that is, trustworthiness.
(84)
The second prong of admissibility under FRE 702 is that the evidence must
be relevant or assist the trier of the fact in understanding or determining a fact in
issue.(85) The court must determine, pursuant to FRE 104(a), whether a scientific expert
is proposing to testify about scientific knowledge that will assist the trier of the fact to
understand an issue in fact.(86)
To make this determination, the court suggested a number of possible tests
or criteria. But it pointed out that it was not creating a definitive checklist, but only
some helpful guidelines, not all of which (or perhaps any) are necessarily
6 ABR 453
applicable in a specific given case.(87) In the case of the scientific evidence being offered by an expert,
the court suggested that the following four factors might be considered:
- Has the theory or technique been tested?
- Has it been subject to peer review?
- Is there any known or potential rate of error?
- Does it have "general acceptance" in the scientific community?
The court said:(88)
The inquiry envisioned by Rule 702 is, we
emphasize, a flexible one. Its overarching subject
is the scientific validity and thus the evidentiary
relevance and reliability--of the principles that
underlie a proposed submission. The focus, of
course, must be solely on principles and
methodology, not on the conclusions that they
generate. [footnotes omitted]
Daubert was remanded to the 9th Circuit for application of the new
standard, and that court again upheld the district court's decision.
(89)
In In re Joiner,(90) the Supreme Court determined that the standard of
review, whether the expert testimony was admitted or excluded, was an abuse of
discretion standard.
6 ABR 454
In the Kumho Tire case,(91) the court noted:
...where such testimony's factual basis, data,
principles, methods, or their application are called
sufficiently into question...the trial judge must
determine whether the testimony has "a reliable
basis in the knowledge and experience of [the
relevant] discipline." [citation omitted]
Kumho involved injuries caused by a tire blowout. The tire manufacturer
was sued. The plaintiff presented the testimony of an expert who had a master's
degree in mechanical engineering and worked for ten years at Michelin America, Inc.
(92)
His qualifications were not questioned by the district court.
The defendant tire company moved for summary judgment and the district
court determined that the testimony of plaintiff's expert in response should be excluded.
The expert had concluded that the tire failure occurred because of a defect in the tire
rather than some other cause such as a blowout condition caused by under-inflation.
(93)
The district court questioned the reasonableness of the expert's approach and found it
was too subjective.(94)
The 11th Circuit reversed, but was itself reversed by the Supreme Court,
which approved of the district court's exclusion of the testimony based on the wide
latitude or discretion it gave to the district court's ruling.
6 ABR 455
Finally, an expert's testimony can also be excluded where there is no
proper factual foundation for the conclusion.(95) As I have alluded to before and will
again, the biggest criticism Elggren had about MacPhee's analysis is principally backed
up by his erroneous view of the facts surrounding the "$9,000,000" in ticket revenues.
This is but one reason his expert opinion must be excluded.
4.3. Mr. Elggren "Gets the Gate"- Applying the general principles
described in the Daubert, Joiner, Kumho trilogy discussed in part 4.2 of this
Memorandum, it is readily apparent that the court should exclude the expert testimony
of Wayne Elggren, notwithstanding his substantial qualifications.
The reasons, many of which have been broached in Part 2.4 of this Memorandum, are:
- Elggren has a gross misunderstanding of the facts which surrounded
the "$9,000,000 in ticket revenue;"(96) that was a hypothetical figure,
not an actual reflection of debtors' ticket revenue.
- Elggren's use of a 20% markup or 83.33% gross margin percentage
is without substantial foundation. It does not appear to be based on
any study of the debtors' records, but is based on an offhand remark
by a travel agent about conditions that existed in the mid-1980's for
Discount World Travel, which quit its business about the time
Bonham began hers. This is speculative and unsubstantiated.
-
6 ABR 456
Elggren points to a number of individual items which he views as
incorrect and incorrectly analyzed by the trustee, but, in general,
they do not amount to a substantial sum of money. Nor is there any
indication from the few errors he has pointed out that such errors are
rife in the trustee's calculations.
- Elggren indicates that the trustee uses the wrong methodology in
arriving at gross income and suggests that the reservation cards
themselves, as primary source documents, should have been
reviewed. He has not given any indication that he has done this
himself, even on a test basis, to show that MacPhee's analysis about
the gross income of the ticket business is substantially incorrect.
- Elggren uses arguments which are undeniably fallacious or
unsubstantial. For example, it is sophomoric to compare the high
profits realized by certain mutual funds to those promised by
debtors. And, suggesting that the debtors did not operate a Ponzi
scheme because most Ponzi operations do not last seven years is a
weak argument. There are a number of cases in which Ponzi
schemes have lasted at least that long.
He also makes a patently incorrect statement that "a 'Ponzi'
operator is inherently insolvent at all times because with no source of
'income' except investor borrowing, each investment contract
deepens his or her insolvency." In fact, most Ponzi schemes have at
least a semblance, if not a somewhat substantial, operating "front."
-
6 ABR 457
He has not explained the need for so many investors or investment
contracts when the ticket buyers generally paid up front and the
physical assets of World Plus were modest. How did Bonham wind
up with $746,000 in outstanding investment contracts in 1989,
increasing to $50,000,000 when debtors were shut down in
December 1995?
- He is critical about methodology but has not shown by practical
examples how the trustee's analysis is wrong or that his is better.
- Mr. Elggren criticized the trustee for not getting original frequent
flyer mileage broker records listing approximately fifty-one frequent
flyer ticket brokers.(97) He also
criticized the trustee and MacPhee for utilizing the cost of tickets sold as
derived from the broker books, summaries, and bank records, and suggests they
should have relied instead on the reservation cards. Other than making these
criticisms, the defendants have done nothing to back these assertions with any
facts.
Elggren has not quantified what the analysis of the
reservation cards would show, nor how it would differ from the
trustee's and MacPhee's analyses. He appears principally to have
seized on this because of the $9,000,000 ticket "revenue" he
wrongfully deduced from the Delta Air Lines' settlement.
The defendants indicated in this proceeding that they
themselves were investigating the frequent flyer mileage brokers
6 ABR 458
to get the detail of Ms. Bonham's dealings with them. This was not
anticipated to be an easy task, since many of these people were
subject to suit by the airlines for violating frequent flyer mileage
policy. Elggren has done nothing to quantify his findings about what
the records of these frequent flyer brokers would show, not even
one of them.
In short, I find that Elggren's report is based on substantial factual
mistakes, speculation, innuendo, and inferences which are not supported by full
explanations and analysis. It is not worthy of an expert of his caliber, nor worthy of
admission as evidence in this case. His expert opinion will be excluded.
4.4. The Trustee's Analysis, Based
on the Percentage Markup Method, is Reasonable and the Trustee Has Established a
Six-Year Ponzi Scheme Beyond Question-
The methodology used by the trustee appears to be sound. MacPhee determined that
the most reliable figures in the jumble of unorganized checks, commingled bank
accounts and funds, and incomplete records, appear to be the amounts that debtors paid
to purchase frequent flyer miles from brokers. MacPhee and the trustee derived these
costs from every reasonably available source. MacPhee derived the percentage markup
from monthly summaries prepared by Ms. Bonham at about the time the tickets were
purchased.
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Where the cost of goods sold and the gross profit percentage are known,
the "percentage markup" method of deriving gross income is well recognized. For
example, in Webb v. Commissioner of Internal Revenue,(98) the court said:
For Webb the percentage markup method
was the most reasonable means of computing
income because his cost of sales in each taxable
year was known with certainty. In comparison,
net worth or bank deposit computations would
lack any known figure because Webb transacted
a substantial amount of his liquor business in
cash, and he readily commingled cash flowing to
and from personal and business expenses.
The trustee need not show that his analysis is exact to the penny, nor
would anyone expect such accuracy from the records he had to deal with. It is enough
to show that he has substantially captured the dynamics of debtors' business, and not
grossly exaggerated the financial picture. Given the picture shown in the graph at the
beginning of this Memorandum, he hardly needs to exaggerate or cut corners to show
that the debtors operated a Ponzi scheme.
5. CONCLUSION- Given the ever increasing portfolio of investment
contracts marketed by debtors from 1988, and the ever decreasing income and
profitability from ticket sales, I conclude that debtors operated a Ponzi scheme as
defined in Part 2.1 of this Memorandum for at least six years before the petition date.
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I will enter an order that the existence of a Ponzi scheme for at least six
years before the petition date has been established without substantial controversy.
(99)
| DATED: April 7, 2000 | |
| | HERBERT A. ROSS |
| | U.S. Bankruptcy Judge |
N O T E S:
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1. Many issues common to all defendants are being addressed in the present lead
proceeding, In re BONHAM RECOVERY ACTIONS, a proceeding to jointly administer certain pre-trial
issues in numerous related adversary proceedings (referred to as the "BRA").
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2. Motion and Memorandum in Support of Motion for Partial Summary Judgment That
Debtor Operated a Ponzi Scheme; and on Fraudulent Conveyance Causes of Action; and for Rule
54(b) Final Judgment for Preference Recipients and Against "Net Gainers" to the Extent of Their
Net Gains, Docket Entry 318 filed January 9, 1998, and Docket Entry 319 filed January 6, 1998.
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3. Daubert v Merrell Dow Pharmaceuticals, Inc., 509 US 579, 113 SCt 2786, 125 LEd2d
469 (1993); see discussion in Part 4.2.
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4. A graphical representation of the table entitled Investment Deposits as a Percentage of
Total Revenue at page 20 of this Memorandum.
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5. Hayes v Palm Seedlings Partners-A (In re Agricultural Research and Technology Group,
Inc.) 916 F2d 528, 531 (9th Cir 1990) [citation omitted].
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6. In re Bonham, 226 BR 56 (Bankr D Alaska 1998).
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7. See, Footnote 2.
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8. Summarized principally from Amended Defendants' Memorandum in Support of
Opposition to Trustee's Motion for Partial Summary Judgment That Debtor Operated a "Ponzi"
Scheme; and on Fraudulent Conveyance Causes of Action; and for Rule 54(b) Final Judgment for
Preference Recipients and Against "Net Gainers" to the Extent of Their Net Gain ["Defendants'
Memorandum"], Docket Entry 661, filed October 5, 1998, at 11-15; and Affidavit of Larry D.
Compton in Support of Motion for Partial Summary Judgment That Debtor Operated a "Ponzi"
Scheme; and on Fraudulent Conveyance Causes of Action; and for Rule 54(b) Final Judgment for
Preference Recipients and Against "Net Gainers" to the Extent of Their Net Gain ["First Compton
Affidavit"], Docket Entry 322, filed January 6, 1998, at 5-7 (¶¶ 10-17).
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9. First Compton Affidavit, ¶ 15, Docket Entry 322.
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10. Deposition of RaeJean Bonham at 17-19, Delta Air Lines, Inc. v Seward et al, Case No.
1:93-CV-1036-HTW (ND Ga), accompanying Defendants' Memorandum, Docket Entry 661.
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11. Id at 24.
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12. See, First Compton Affidavit, ¶ 7, Docket Entry 322.
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13. Declaration of Carol Walrath, ¶ 2 [Affidavit of Gary Spraker (First Spraker Affidavit),
Docket Entry 323, filed January 6, 1998, Exhibit 11]; Declaration of Betty Ann Troyn, ¶ 2 [First
Spraker Affidavit, Exhibit 12]; Declaration of Melanie Cook, ¶ 2, [Index to Documents Supporting
Statement of Facts, Exhibit 10, Docket Entry 662 filed October 5, 1998].
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14. Deposition of Stephanie Bonham DeGroot, at 107, 123-24 [Index to Documents
Supporting Statement of Facts, Exhibit 12, Docket Entry 662].
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15. See, First Compton Affidavit, at ¶ 20.
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16. See, First Compton Affidavit, ¶ 18 and attached Exhibit 2.
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17. See, Exhibit 1 to the Declaration of Noelle Martinez, Exhibit 5, First Spraker Affidavit;
see also, Deposition of Tim Kellis, at 17 (sale of cruise miles supported 50% contracts), Exhibit 6,
First Spraker Affidavit.
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18. See, Plea Agreement in United States v Bonham, USDC Case No. A97-0115-CR (HRH)
(D Alaska), at 4; Supplemental Affidavit of Gary Spraker (Second Spraker Affidavit), Exhibit 19,
Docket Entry 728 filed December 4, 1998; see also, Depositions of Phillip Wilson (Hewlett
Packard), at 12-16; Leo Lucio (SONY), at 7-18; Clarence Bolivar (Apple Computer), at 6-14; and
the Declaration of Paul Hardisty (IBM), Exhibit 10 to the First Spraker Affidavit, Docket Entry 323.
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19. Plea Agreement, ¶ VII.8, United States v Bonham, USDC Case No. A97-0115-CR (HRH).
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20. See, First MacPhee Affidavit, Exhibit G, Docket Entry 320.
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21. See, First Compton Affidavit; see also, Affidavit of Carleen Mangold, Docket Entry 321 filed January 6, 1998.
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22. First Compton Affidavit, ¶ 33.
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23. Notice of Supplemental Affidavit of Jayne MacPhee in Support of Trustee's Motion for
Partial Summary Judgment on Fraudulent Conveyance Causes of Action (Second MacPhee
Affidavit), ¶¶ 7-8, Docket Entry 707 filed November 13, 1998.
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24. Second MacPhee Affidavit, ¶¶ 10, 12; Supplemental Affidavit of E. Jayne MacPhee
(Third MacPhee Affidavit), ¶ 1, Docket Entry 729 filed December 4, 1998.
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25. Second MacPhee Affidavit, ¶¶ 14-19; Third MacPhee Affidavit, ¶ 1.
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26. Third MacPhee Affidavit, ¶ 1.
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27. First Compton Affidavit, Exhibit 13, at 1-15; First MacPhee Affidavit, Exhibit E.
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28. Second MacPhee Affidavit, Exhibits D and E; Third MacPhee Affidavit, Exhibits C and D.
6 ABR 426
29. Second MacPhee Affidavit, Exhibit D; Third MacPhee Affidavit, Exhibit D.
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30. First MacPhee Affidavit, Exhibit D.
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31. First Compton Affidavit, Exhibit 13.
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32. Second MacPhee Affidavit, ¶ 15, Exhibit E; Third MacPhee Affidavit, ¶ 5, Exhibit C.
6 ABR 428
33. Second Compton Affidavit, ¶¶ 8 and 13, Exhibits 22 and 26 (prior to December 1989).
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34. First Compton Affidavit, ¶ 31, Exhibit 15.
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35. First Compton Affidavit, ¶ 31, Exhibit 17, at 1-8.
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36. Second MacPhee Affidavit, Exhibit C.
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37. Third MacPhee Affidavit, Exhibit C.
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38. First Compton Affidavit.
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39. Second MacPhee Affidavit, Exhibit F.
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40. Second MacPhee Affidavit, ¶ 21 and Exhibit F.
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41. See, table at 17.
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42. See, table at 18
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43. See, Second MacPhee Affidavit, Exhibit H.
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44. See, Second MacPhee Affidavit, Exhibit H.
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45. Supplemental Declaration and Report of F. Wayne Elggren, ¶¶ 18-27, Docket Entry 670, filed October 8, 1998.
6 ABR 436
46. See, Affidavit of Jeffrey W. Willis (Delta's attorney), Docket Entry 727, filed December 4, 1998.
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47. Supplemental Declaration and Report of F. Wayne Elggren, ¶ 28, Docket Entry 670.
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48. Id. at ¶ 29.
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49. Id. at ¶¶ 30-32.
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50. Plaintiff's Reply Memorandum to Defendants' Consolidated Opposition to Motion for
Partial Summary Judgment, ¶ B.1, at 9, Docket Entry 726 filed December 4, 1998.
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51. Supplemental Affidavit of Larry D. Compton, Docket Entry 730 filed December 4, 1998.
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52. Reproduction of the table shown at page 23 of this Memoradum.
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53. Supplemental Declaration and Report of F. Wayne Elggren, ¶ 23.
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54. Notice of Filing Faxed Declaration and Report, at ¶ 16, Docket Entry 558, filed June 15, 1998.
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55. Id. at ¶¶ 33-35.
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56. Plaintiff's Reply Memorandum to Defendants' Consolidated Opposition to Motion for
Partial Summary Judgment, ¶ C.1, at 15, Docket Entry 726 filed December 4, 1998.
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57. Supplemental Declaration and Report of F. Wayne Elggren, ¶¶ 37-39.
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58. Id. at ¶ 40.
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59. Id. at ¶¶ 41-43.
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60. Id. at ¶ 44.
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61. Plaintiff's Reply Memorandum to Defendants' Consolidated Opposition to Motion for
Partial Summary Judgment, ¶ B.4, at 12-13.
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62. Supplemental Declaration and Report of F. Wayne Elggren, ¶¶ 45-47.
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63. Id. at ¶¶ 48-50.
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64. Id. at ¶ 51.
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65. Id. at ¶¶ 52-56.
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66. See, complaint in Kronfeld v Bennett, Case No. 96 Civ 2583 (United States District
Court for the SDNY) which can be viewed at http://securities.stanford.edu/cases/bennett.html.
6 ABR 446
67. Supplemental Declaration and Report of F. Wayne Elggren, at 19-20.
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68. FRCP 56(d), incorporated by FRBP 7056.
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69. FRE 702, incorporated in bankruptcy proceedings by FRBP 9017.
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70. Computer Systems Engineering, Inv. v Qantel Corp., 740 F2d 59, 67 (1st Cir 1984).
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71. United States v Garcia, 7 F3d 885, 889 (9th Cir 1993).
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72. Hingson v Pacific Southwest Airlines, 743 F2d 1408, 1412-13 (9th Cir 1984); Dunn v
Sears, Roebuck & Co., 639 F2d 1171, 1174 (5th Cir 1981); Independent Living Resources v
Oregon Arena Corp., 982 FSupp 698, 784 and fn 116 (D Ore 1997).
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73. Lewis v Scott (In re Lewis), 97 F3d 1182 (9th Cir 1996).
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74. Id.; Sugai v General Motors Corp., 137 FSupp 696, 700 (D Ida 1956).
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75. In re Dow Corning Corp., 237 BR 364, 371, fn 23 (Bankr ED Mich 1999).
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76. Daubert v Merrell Dow Pharmaceuticals, Inc., 509 US 579, 113 SCt 2786, 125 LEd2d 469 (1993).
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77. Kumho Tire Co., Ltd. v Carmichael, 526 US 137, 119 SCt 1167, 143 LEd2d 238 (1999).
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78. See, Daubert v Merrell Dow Pharmaceuticals, Inc., 951 F2d 1128 (9th Cir 1991).
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79. Daubert, 113 SCt at 2792, fn 2.
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80. 293 F 1013, 1014 (DC App 1923).
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81. Daubert, 113 SCt at 2792; Daubert, 951 F2d at 1129-1130.
6 ABR 452
82. Daubert, 113 SCt at 2792-94.
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83. Daubert, 113 SCt at 2795.
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84. Daubert, 113 SCt at 2795, fn 9.
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85. Daubert, 113 SCt at 2795-96.
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86. Daubert, 113 SCt at 2796.
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87. Daubert, 113 SCt at 2796; United States v Hankey, 203 F3d 1160, 1167-68 (9th Cir 2000).
6 ABR 453
88. Daubert, 113 SCt at 2797.
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89. Daubert, 43 F3d 1311 (9th Cir 1995).
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90. General Electric Company v Joiner, 522 US at 141-142; 118 SCt at 517; 139 LEd2d 508 (1997).
6 ABR 454
91. Kumho Tire Company, Ltd. v Carmichael, 119 SCt at 1175.
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92. Kumho Tire Company, Ltd. v Carmichael, 119 SCt at 1176-77.
6 ABR 454
93. Kumho Tire Company, Ltd. v Carmichael, 119 SCt at 1172.
6 ABR 454
94. Kumho Tire Company, Ltd. v Carmichael, 119 SCt at 1177-78.
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95. Comer v American Electric Power, 63 FSupp2d 927, 934-36 (ND Ind 1999).
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96. See, Part 2.4 of this Memorandum at 23.
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97. Notice of Filing Faxed Declaration and Report, at ¶ 16, Docket Entry 558, filed June 15, 1998.
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98. 394 F2d 366, 373 (5th Cir 1968); Bollella v Commissioner of Internal Revenue, 374 F2d
96 (6th Cir 1967), affg TC Memo, 1965-162 (Tax Ct 1965); Lambaiso v Commissioner of Internal
Revenue, TC Memo 1999-343 (Tax Ct 1999).
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99. FRCP 56(d), incorporated by FRBP 7056.