In re Lake States Commodities, Inc.

• Court: U.S. Bankruptcy Court — Northern District of Illinois
• Writing for the Court: Susan Pierson Sonderby
• Citation: In re Lake States Commodities, Inc., 272 B.R. 233 (Bankr. N.D. Ill. 2002)
• Decision Date: 11 January 2002
• Docket Number: Bankruptcy No. 94 B 12123.,Bankruptcy No. 94 B 12125.,Adversary No. 96 A 00834.
• Parties: In re LAKE STATES COMMODITIES, INC. a/k/a Lake States, Inc., Debtor. Thomas W. Collins, Debtor. Lawrence Fisher, as Trustee of the Estate of Lake States Commodities, Inc., a/k/a Lake States, Inc., and as Trustee of the Estate of Thomas W. Collins, Plaintiff, v. John Sellas, Defendant.

272 B.R. 233

In re LAKE STATES COMMODITIES, INC. a/k/a Lake States, Inc., Debtor Thomas W. Collins, Debtor Lawrence Fisher, as Trustee of the Estate of Lake States Commodities, Inc., a/k/a Lake States, Inc., and as Trustee of the Estate of Thomas W. Collins, Plaintiff, v. John Sellas, Defendant.

Bankruptcy No. 94 B 12123.

Bankruptcy No. 94 B 12125.

Adversary No. 96 A 00834.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

January 11, 2002.

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Michael J. Koenigsknecht, Gardner, Carton & Douglas, Chicago, IL, for Plaintiff.

Larry M. Wolfson, Thomas S. O'Neill, Vincent E. Lazar & Terence G. Banich II, Jenner & Block, LLC, Chicago, IL, for Defendant.

Lawrence Fisher, Law Offices of Lawrence Fisher & Associates, Chicago, IL, trustee.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

SUSAN PIERSON SONDERBY, Bankruptcy Judge.

I. FINDINGS OF FACT

This cause comes to be heard on the motion of defendant for entry of judgment on partial findings in accordance with Rule 7052(c) of the Federal Rules of Bankruptcy Procedure ("Bankruptcy Rules") upon the conclusion of the plaintiff's case-in-chief at the joint trial on common issues; whether the debtor Lake States Commodities, Inc. a/k/a Lake States, Inc. ("Lake States") was insolvent at the relevant time pursuant to statute and whether Lake States was operated as a Ponzi scheme. For the reasons stated herein, the motion is granted.

A. Background

1. On June 16, 1994 (the "Petition Date"), involuntary petitions for relief under chapter 7 of title 11 of the United States Code (the "Code") were filed against Lake States and Thomas W. Collins ("Collins"). Lake States and Collins are sometimes collectively referred to as the "Debtors." Orders for relief under chapter 7 of the Code were entered in both cases. On July 13, 1994, this Court ordered the substantive consolidation of the estates pursuant to Bankruptcy Rule 1015.

2. Lakes States, an Illinois corporation, whose principal place of business was located in Rolling Meadows, Illinois, was in the business of soliciting investors for commodity futures trading and participating in commodity pools. Collins, who is now deceased, was a resident of Illinois and was president and a shareholder of Lake States. Collins' brother, Edward Collins, was a vice-president of Lake States.

3. William A. Brandt, Jr. was appointed to serve as interim chapter 7 trustee on July 14, 1994 (the "Interim Trustee"). Lawrence Fisher (the "Trustee") was elected to serve as chapter 7 trustee on October 26, 1994, and continues to serve in that capacity.

4. During his brief tenure, the Interim Trustee retained KPMG Peat Marwick, LLP ("KPMG") to render accounting services on behalf of the estates. Upon his election, the Trustee continued the retention of KPMG. KPMG disbanded and the Trustee continued the retention of the former KPMG accountants who became employed by Ernst & Young.

5. On June 14, 1996, the Trustee filed a number of adversary complaints against investors in Lake States, seeking to recover payments made by Lake States to the defendants as fraudulent conveyances under Sections 548(a)(1)(A) and (a)(1)(B) of the Code and Sections 5(a)(1), 5(a)(2) and (6) of the Illinois Uniform Fraudulent Transfer Act, 740 ILCS 160/1, et seq. ("UFTA"), applicable here by reason of the Trustee's avoiding powers under Section 544(b) of the Code. Many of the fraudulent transfer adversary proceedings were settled, leaving 21 proceedings, including this adversary proceeding, remaining (the "Remaining Adversary Proceedings").

6. On January 25, 2001, this Court ordered that a joint trial of the issues common to the Remaining Adversary Proceedings be conducted on May 7, 2001. The central issues at trial were whether Lake States was insolvent at the relevant time and whether Lake States was operated as a Ponzi scheme. The defendants, including the defendant herein, who participated in the joint trial are collectively referred to as the "Defendants."

B. Evidence at the Trial

7. At the trial, the Trustee attempted to introduce evidence during his case-in-chief via the following means: the testimony of the Trustee; four documents; the testimony of the Trustee's expert Kenneth J. Malek ("Malek"); and the expert's report. The four documents, which are defined and discussed in detail below, are the KPMG Report, the Net Cash Report, and the Indictment and Criminal Docket from the criminal proceedings against Edward Collins.

(i) The Trustee's Testimony

8. The Trustee testified regarding Lake States' business operations, particularly the details concerning Lake States' solicitation of investors and the manner in which Lake States paid its investors.

9. The Court sustained the Defendants' objections and excluded the Trustee's testimony under Rule 602 of the Federal Rules of Evidence (F.R.E.) because the Trustee lacked personal knowledge of Lake States' business operations.

(ii) The KPMG Report and the Net Cash Report

10. During his testimony, the Trustee discussed the following documents:

(i) certain of Lake States' financial documents, including: (a) canceled checks; (b) cash receipts; (c) cash disbursements; (d) cash ledgers; (e) bank statements; (f) investor files¹ containing: promissory notes, participation certificates for commodity pools, monthly roll-forward statements detailing cash balances, correspondence, and ledger sheets; (g) a report titled "Net Cash Position Roll-Forward," which purported to summarize each investor's investment activity (the "Net Cash Report"); and (h) account statements with the Iowa Grain and Geldermann, Inc. clearing firms (the "Clearing Firm Account Statements") (items (a) through (h) are collectively referred to as the "Business Records"); and

(ii) a report prepared by Ford Phillips ("Phillips"), an employee of KPMG, which summarized the Clearing Firm Account Statements and other Business Records (the "KPMG Report").

11. The Interim Trustee delivered the Business Records to the Trustee, who in turn delivered the Business Records to KPMG for review and analysis. The Trustee had no personal knowledge of and did not assist in any way in the preparation or maintenance of the Business Records.

12. The Trustee testified regarding the results of KPMG's review and analysis of the Business Records and the contents of the KPMG Report. The Court sustained the Defendants' objections and excluded the Trustee's testimony under F.R.E. 602 because the Trustee lacked personal knowledge of these matters.

13. The Trustee sought the introduction of the KPMG Report and the Net Cash Report into evidence.

14. In this regard, on cross-examination, the Trustee noted that he did not cause the issuance of subpoenas directed to any of the several former employees of Lake States who may have had personal knowledge of Lake States' business or who could have laid a foundation for the introduction of the Business Records. The Trustee confirmed that he did not receive any affirmative indication that any of the former employees would refuse to testify in response to a subpoena, although he doubted that they would testify.

15. The Trustee did not call Phillips or any other former employee of KPMG to testify about the KPMG Report or KPMG's review of the Business Records. The Trustee did not call any bank or clearing-account firm employees to lay a foundation for the Clearing Firm Accounts or bank records.

16. During the direct examination of the Trustee and in the face of continuing objections by the Defendants to the admission of the KPMG Report and the Net Cash Reports into evidence, the Trustee's counsel indicated that he would attempt to lay the foundation for the admission of the KPMG Report and the Net Cash Report through the Trustee's expert witness.

17. Rather than using the expert witness, however, the Trustee was recalled to the witness stand to try to lay the foundation for the KPMG Report and Net Cash Report. Again, foundation objections were raised by the Defendants and sustained by the Court. As a result, the KPMG Report and the Net Cash Report were not admitted into evidence.

(iii) The Expert's Testimony and Report

18. Malek was retained by the Trustee as an expert to provide opinions regarding whether a Ponzi scheme existed and whether Lake States was insolvent. At the trial, Malek tendered his report which contained statements of his opinions, a description of the sources and basis of his opinions, and his curriculum vitae (the "Malek Report").

19. Malek is a certified public accountant and a certified insolvency and restructuring advisor with over 20 years of experience specializing in insolvency, restructuring, and workout situations. Malek is a director of Navigant Consulting, Inc. ("Navigant"), an international, publicly traded consulting firm with offices in more than fifty cities nationwide and seventeen offices located overseas. Malek is a Fellow of the American College of Bankruptcy and he, at the time of the trial, was the immediate past president of the Association of Insolvency and Restructuring Advisors. Malek has testified in numerous bankruptcy cases, primarily in this District, as an expert giving opinions on such issues as insolvency; valuations of real estate, stock interests, and business enterprises; and plan feasibility. Malek was retained in prior cases to render opinions involving three separate Ponzi schemes.

20. In the Malek Report, Malek opined about the accuracy of the KPMG Report:

"The KPMG Peat Marwick data base contains over 11,598 transactions, obtained from prepetition bank records, check registers, investor rollforwards maintained by Lake States personnel and other records analyzed by KPMG Peat Marwick. Navigant tested the accuracy of the KPMG Peat Marwick data base by tracing and agreeing a sample of cash transactions reported therein to and from the bank statements and other records. The only exception noted in this testing was that...