Securities and Exchange Commission v. Nadel et al

Filing 1145

Third Interim Report on Quest Energy Management, Inc. (May 24, 2014 to November 4, 2014) by Burton W. Wiand. (Attachments: # 1 Exhibit A - Status of wells, # 2 Exhibit B - Cash Accounting Report)(Morello, Gianluca) Modified text on 11/5/2014 (KMB).

UNITED STATES DISTRICT COURT
MIDDLE DISTRICT OF FLORIDA
TAMPA DIVISION
SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,
v.

Case No. 8:09-cv-0087-T-26TBM

ARTHUR NADEL;
SCOOP CAPITAL, LLC;
SCOOP MANAGEMENT, INC.
Defendants,
SCOOP REAL ESTATE, L.P.;
VALHALLA INVESTMENT PARTNERS, L.P.;
VALHALLA MANAGEMENT, INC.;
VICTORY IRA FUND, LTD.;
VICTORY FUND, LTD.;
VIKING IRA FUND, LLC;
VIKING FUND, LLC; AND
VIKING MANAGEMENT, LLC,
Relief Defendants.
____________________________________/
THE RECEIVER’S THIRD INTERIM REPORT ON
QUEST ENERGY MANAGEMENT GROUP, INC.
Burton W. Wiand, the Court-appointed Receiver for Quest Energy Management
Group, Inc. (“Quest” or the “Company”), hereby files this Third Interim Report On Quest
(the “Report”) to inform the Court, investors, and others interested in this Receivership of

activities from May 24, 2014 through the date of the filing of this Report as well as the
proposed course of action.1
BACKGROUND
On January 21, 2009, the Securities and Exchange Commission (“SEC”) instituted
this enforcement action following the collapse of a massive Ponzi scheme (the “scheme”)
perpetrated by Arthur Nadel (“Nadel”) through hedge funds (the “Hedge Funds”) from 1999
until January 2009. As part of this scheme, Nadel paid himself and his purported business
partners, Neil and Christopher Moody (“the Moodys”), more than $90 million in bogus
management and performance fees which were based on fabricated asset values and
performance data. Due to that conduct, Nadel was charged and pled guilty to securities,
mail, and wire fraud. Nadel pled guilty to all charges and died in prison while serving a 14year sentence.
During the course of the ten-year scheme, Nadel and the Moodys used scheme
proceeds – money stolen from the Hedge Funds’ investors – to found or otherwise fund
numerous businesses. Since the inception of this Receivership and in accordance with his
mandate to marshal assets for the benefit of defrauded investors, the Receiver has

1

The Receiver’s Second Interim Report on Quest covered the time from August 27,
2013 through May 23, 2014 (the “Second Quest Report”). The Second Quest Report and
the prior Interim Report can be found on the Receiver’s website,
www.nadelreceivership.com.

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successfully sought expansion of the Receivership to include those businesses.2 Quest is one
such entity that was funded in large part with scheme proceeds.
Quest is an oil and gas exploration and production company based in Texas. Paul
Downey was its Chief Executive Office, and his son Jeffry Downey was its Chief Operating
Officer (collectively the “Downeys”).

The Moodys, through Viking Oil, used scheme

proceeds of $4 million to fund Quest. Through Valhalla Investment Partners, L.P., the
Moodys funneled an additional $1.1 million to Quest in exchange for a promissory note from
Quest and the Downeys to Valhalla Investment Partners. In February 2009, the Receiver
began communications with the Downeys for recovery of the scheme proceeds provided to
Quest. After considerable time and effort, the Receiver reached a conditional agreement to
resolve his claims against Quest dependent upon receipt of $2.3 million from Quest. Quest
failed to make this payment and ignored the Receiver’s repeated demands for payment. In
February 2013, Quest informed the Receiver it was having cash flow problems. Because of
Quest’s failings and to try to preserve Quest’s value for the benefit of the Receivership estate
and, ultimately, for defrauded investors in Nadel’s scheme, on March 21, 2013, the Receiver

2

Those business include: Venice Jet Center, LLC; Tradewind, LLC; Laurel Mountain
Preserve, LLC; Laurel Preserve, LLC; Laurel Mountain Preserve Homeowners Association,
Inc.; Marguerite J. Nadel Revocable Trust UAD 8/2/07; Guy-Nadel Foundation, Inc.; Lime
Avenue Enterprises, LLC; A Victorian Garden Florist, LLC; Viking Oil & Gas, LLC; Home
Front Homes, LLC; Traders Investment Club; Summer Place Development Corporation;
Respiro, Inc.; and Quest Energy Management Group, Inc. For more information on the
Receivership as a whole, please refer to the Receiver’s regularly filed Interim Reports.

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moved to expand the Receivership to include Quest (Doc. 993). The Court granted this
motion on May 24, 2013 (Doc. 1024).3
I.

Brief Overview of Receiver’s Efforts to Date
Since his appointment on May 24, 2013, the Receiver has taken a number of steps to

fulfill his mandates under the Order appointing him as Receiver for Quest. The Receiver and
his attorneys promptly secured bank accounts and began to review Quest’s business records.
The Receiver traveled to Texas to secure Quest’s office, interview personnel, and examine
records and assets.4 The Receiver also retained the services of Wheeler, Fairman & Kelley,
CPAs (“Wheeler”), experienced forensic accountants in Texas familiar with the oil and gas
industry, to examine Quest’s financial records.
After reviewing Quest’s operations and communicating with individuals experienced
with the oil and gas exploration industry, it quickly became clear that Quest’s operations
3

On June 14, 2013, the Downeys filed a notice of appeal of the Court’s May 24, 2013
Order to the United States Court of Appeals for the Eleventh Circuit in the name of Quest
(Doc. 1027). On July 19, 2013, the appellate court informed the parties that it may lack
jurisdiction over the appeal and requested briefing on this issue. On August 2, 2013, the
Receiver filed his response and also moved to dismiss the appeal for lack of jurisdiction on
other grounds. On September 17, 2013, the appellate court ordered that the motion to
dismiss and other jurisdictional issues will be carried with the case. Oral argument before the
Eleventh Circuit was had on May 13, 2014. On September 25, 2014, the appellate court
ruled in favor of the Receiver finding that the Downeys lacked standing to appeal on behalf
of a company over which they have no authority. Accordingly, the appellate court dismissed
the appeal.
4

On June 5, 2013, the Receiver’s attorney deposed Paul Downey in an effort to gather
important information about Quest’s affairs under oath. However, Mr. Downey asserted his
Fifth Amendment privilege against self-incrimination and refused to answer any questions
without first receiving immunity from prosecution. When asked to provide evidence before
the Court, counsel for Jeffry Downey indicated he would also rely on his constitutional
privileges and not testify.

4

were in dire straits. As discussed below, Quest faced serious regulatory issues which had
resulted in its license to operate being suspended. The Receiver realized that to have any
meaningful sale of Quest or its assets, he first had to resolve its many regulatory issues. The
Receiver and his professionals have spent considerable time and effort resolving these
regulatory issues to ensure that Quest would remain viable. While tackling these regulatory
issues, the Receiver also discovered that basic well maintenance and well management had
been ignored. At the time of the Receiver’s appointment, Quest was producing less than
seven barrels of oil per day. The Receiver implemented a repair and maintenance plan
designed to increase oil and gas production while being mindful of the costs of such a plan.
The Receiver’s efforts have been fruitful. Quest has its license to operate, is working
diligently to remain in compliance with applicable regulations, and its wells are collectively
producing on average approximately 33 barrels of oil per day.

Since the Receiver’s

appointment, he has more than doubled production. Now that the Receiver has overcome
many of the serious problems Quest faced at the time of his appointment, he has turned his
focus to (1) further improving well production where possible and economically feasible and
(2) selling Quest and its assets.
A.

Overview of Findings to Date

The Receiver has formed some conclusions based on his initial review of a portion of
the records obtained from Quest. While these conclusions are not final, and may change as
the review becomes more complete, the Receiver believes they should be shared with the
Court, the investors, and other potentially interested parties. As a result of his actions and
investigations, the Receiver has discovered that Quest (1) was severely mismanaged, in

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default of millions of dollars of outstanding debt, and insolvent; (2) had serious regulatory
issues; (3) was sustained exclusively by money from new investors who were misled about
the company’s financial state or potential; and (4) was a defendant in several lawsuits and
was facing other potential litigation. These findings are discussed below.
1.

Quest Was Insolvent and Seriously Mismanaged

Upon review, the Receiver discovered that Quest’s financial records were in disarray.
Despite this challenge, the Receiver has been able to determine that Quest was insolvent
almost since its inception in 2006 and expenses were outpacing revenue by more than two to
one. At the time of the Receiver’s appointment, the Company owed investors and others
millions of dollars but had virtually no revenue with which to repay this debt. One way the
Downeys had raised money on behalf of Quest from investors was through promises to repay
the principal amount plus periodic interest.

The Company had ceased making interest

payments to those investors more than one year before the Receiver’s appointment. Quest’s
records reflect that approximately $19,124,326 was raised from investors between 2006 and
May 2013. Due to the disorganized manner in which the Company maintained its financial
records, total liabilities have not been quantified fully yet although it is clear they are very
significant. Further, Quest’s minimal income was insufficient even to satisfy its operating
expenses, let alone its debt obligations. As a result, there was no potential for the Downeys
to satisfy Quest’s obligations other than by using money received from new investors to pay
existing investors. The Company’s operational failure and dire financial condition was not
disclosed to the solicited investors.

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Not only did the Downeys place Quest in dire financial conditions, but they also
failed to properly manage Quest’s oil and gas operations. For instance, (1) due to the
Downeys’ failure to comply with regulatory requirements prior to the Receiver’s
appointment, the renewal of Quest’s Operator’s License had been denied by the Texas
Railroad Commission (“RRC”);5 (2) Quest’s oil and gas wells were in disrepair and the
Downeys failed to make even nominal efforts to maintain them as viable producing assets;
(3) the Downeys failed to file accurate production reports with the RRC; and (4) although the
Downeys raised more than $19 million from investors, it appears no more than $1.5 million
was ever used in connection with the purchase of oil and gas equipment. For more examples
of the Downeys’ mismanagement, please refer to the First Quest Report. As is evident from
the above, without the appointment of the Receiver, the collapse of Quest was inevitable.
2.

Quest Faced Significant Regulatory Issues

Well before the Receiver’s appointment, in 2012, Quest was notified that various
wells were not in compliance with certain regulatory requirements and that because of these
compliance issues the RRC would not renew Quest’s Operator’s License.

Without its

Operator’s License, Quest would have to cease operations. As a result of failures by the
Downeys, on June 13, 2013, the RRC issued an order denying Quest’s renewal application.
Upon learning of the situation, the Receiver took immediate steps to resolve these issues. To
satisfy the RRC’s demands, the Receiver was required to make considerable corrections to

5

The RRC is the primary regulator of the oil and gas industry in Texas. The RRC has
extensive recording and compliance requirements and also has an enforcement division to
enforce those requirements.

7

records which had been improperly filed with the RRC. The Receiver also had to complete
substantial work on a number of wells which included plugging certain wells and resolving
some environmental issues. The Receiver’s professionals and remaining Quest employees
expended extensive efforts to ensure compliance. All of the violations were resolved and
Quest’s Operator’s License was renewed. The Receiver also has renewed Quest’s Operator’s
License for 2014.
The Receiver encountered further problems when it was discovered that production
reports filed with the RRC before the Receiver’s appointment were inaccurate and overstated
production. As a result of these false filings, the RRC severed a number of wells. Once a
well is severed, no production is allowed until the regulatory issue is resolved and a
reconnect fee is paid. The Receiver worked with the RRC to overcome these issues and was
able to secure the RRC’s consent to reconnect the pertinent wells and waive several
reconnect fees. The Receiver retained a consultant to assist with resolving these issues and
securing Quest’s operating license as well as ensuring that the wells remain in compliance
with RRC regulations.
Soon after the filing of the motion to expand the Receivership to include Quest, the
Texas State Securities Board (“TSSB”) contacted the Receiver because it had initiated an
investigation of Quest following complaints by several Quest investors. The TSSB requested
information and assistance in its investigation of Quest and the Downeys’ efforts to raise
money on behalf of the Company. The Receiver cooperated with the TSSB. The TSSB has
since transferred this matter to the SEC’s Fort Worth Regional Office.

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3.

Misrepresentations Made to Investors

The Receiver’s investigation to date indicates that from 2006 through May 2013,
approximately $19 million was raised by the Downeys on behalf of Quest from
approximately 115 investors. Included in this sum is approximately $5.1 million of Nadel
scheme proceeds transferred to Quest by the Moodys. Based on the documents the Receiver
has reviewed to date, it appears that numerous misrepresentations or material omissions were
made to investors. For information regarding these misrepresentations and omissions, please
refer to the Receiver’s First and Second Quest Reports.
The Receiver has sent letters to Quest’s known investors, royalty owners, and other
potential creditors informing them of the Receivership and requesting contact information.
4.

Pending and Prospective Litigation

At the time of the Receiver’s appointment, Quest had three lawsuits seeking large
amounts in damages pending against it in Texas State Courts. Integrity Directional Services,
LLC v. Quest, Case No. 2013-028 (Tx. D. Ct. 259th Jud’l Dist., Shackelford County, TX)
(seeking damages of $899,583.50 for goods and services which were provided to Quest for
which payment was not received); Ploegsma Sulpher Co. LLC v. Quest, Case No. 201317235 (Tx. D. Ct. 189th Jud’l Dist., Harris County, TX) (brought by an investor seeking
damages of more than $1.25 million for payment of a note); Wallace d/b/a Graham Mud Co.
and Rocking R Drilling Co., Inc. v. Quest, Case No. 2013-050 (Tx. D. Ct. 259th Jud’l Dist.,
Shackelford County, TX) (seeking to foreclose on liens for unpaid goods or services in the

9

combined amount of $398,722.93).6 Two taxing authorities also initiated actions against
Quest. Shackelford County Appraisal District v. Quest, Case No. 2013-070 (Tx. D. Ct. 259th
Jud’l Dist., Shackelford Couty, TX) (seeking delinquent property taxes of approximately
$77,200.90); County of Callahan, Texas v. Quest, Case No. T-1994 (Tx. D. Ct. 42nd Jud’l
Dist., Callahan County, Texas) (seeking delinquent property taxes of $1,955.21).

The

Receiver filed Notices of Receivership and Injunction Barring Proceedings Against Quest in
each action. Accordingly, these actions have been stayed as to Quest.
Further, the Receiver has reviewed documents indicating that several investors were
threatening suit against Quest for the recovery of their investments. Absent the appointment
of the Receiver, numerous additional claims were inevitable.
On April 7, 2014, Jeffry Downey and his wife, Pepper Downey, filed a voluntary
petition for relief under Chapter 7 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the Northern District of Texas. The Receiver retained local counsel to
assist with protecting the Receivership’s interests in this matter. On September 9, 2014, the
Receiver filed a motion to take an examination of Jeffry Downey and require him to produce
documents. On September 18, 2014, the Receiver’s counsel conducted the oral examination
of Jeffry Downey and reviewed documents produced by him. On October 16, 2014, the
Receiver filed a complaint contesting the dischargeability of Jeffry Downey’s debt to Quest
and also contesting his ability to obtain a discharge in bankruptcy. The Receiver will

6

These litigation matters are in addition to the Receiver’s claim for approximately $5.1
million against Quest.

10

continue to take all reasonable steps to preserve Quest’s rights and interests in this
bankruptcy proceeding.
II.

Current Operations and Assets
As noted above, upon the Receiver’s appointment, he promptly secured Quest’s bank

accounts and its office located at 64 South Jacobs, Albany, Texas (the “Office”). At the
beginning of the Receivership, Quest had only $22,113.27 in its bank accounts.7

The

Receiver retained experienced forensic information technology experts with the firm EHounds, Inc. to assist in securing and analyzing the electronic data on computers located in
the Office. E-Hounds personnel have secured the data and are well underway in their
forensic analysis.
The Receiver obtained a significant volume of documents from the Office and has
reviewed a substantial number of these documents. The Receiver is continuing to evaluate
the Company’s assets and is attempting to sell these assets. Quest’s assets include (1) leases
held on fields containing oil and gas wells and related equipment; (2) various vehicles; (3)
residential property which is currently being used as the Office; and (4) other miscellaneous
assets including office furniture, computers and the like.
A.

Oil and Gas Wells

Quest maintains leases on three fields which in turn contain 90 gas and oil wells. At
the beginning of the Receiver’s appointment, only five wells were producing. As a result of
the Receiver’s efforts since that time, sixteen wells are producing. This is also an increase

7

Quest’s payables at that time substantially exceeded this amount.

11

from the number of wells which were producing as of the date of the Receiver’s Second
Quest Report. At that time, eleven wells were producing. Attached as Exhibit A to this
Report is a spreadsheet identifying each of these wells and the status of each well. The
Receiver continues to evaluate the potential well output relative to the cost of making the
wells productive. Since taking control of Quest, the Receiver has implemented some repair
and maintenance activities designed to increase production and revenues. As noted above, it
was evident from the Receiver’s review of the wells that simple maintenance and basic well
management had been ignored for some time. The Receiver has more than tripled production
by reinvesting a nominal amount of money in these wells. By taking relatively simple
measures, the Receiver increased production from approximately seven barrels per day to
approximately 33 barrels per day on average. From May 2014 through August 2014, Quest
averaged approximately 33 barrels of oil per day and 237 MCF (thousand cubic feet) of gas
per day, which generated an approximate average gross monthly income of $102,000.
B.

Receivership Accounting Report

Attached as Exhibit B to this Report is a cash accounting report showing the amount
of money on hand as of May 1, 2014 less operating expenses plus revenue through
September 30, 2014. This cash accounting report does not reflect non-cash or cash-equivalent
assets. Thus, the value of all property discussed in this Report is not included in the
accounting report. From May 1, 2014, through September 30, 2014, the Receiver generated
$490,423.10 in gross business income from Quest’s ongoing operations. (Ex. B.) Quest is
generating sufficient income to pay its current operating expenses.

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C.

Vehicles

The Receiver acquired possession and control of 16 vehicles titled in Quest’s name or
otherwise paid for by Quest, which primarily include trucks and trailers used in connection
with business operations. One of the vehicles, however, was a 2009 BMW 535i (“BMW”)
which was being used by Paul Downey. After obtaining Court approval, the Receiver sold
the BMW for $17,000 and received the net amount of $3,566.12 after payment of the
outstanding loan on the vehicle. (Docs. 1049, 1050).
D.

The Office Property

The Receiver has possession and control of the Office, which is a small free-standing
structure. The Office has one known encumbrance: a loan with First National Bank with an
outstanding balance as of May 2014 in the amount of $50,409.98. Parties interested in
purchasing the Office should contact:
David Cleveland
Clear Fork Realty
332 South Second
Albany, Texas 76430
Phone: [phone]
Email: [e-mail]
E.

Miscellaneous Items

The Receiver also has recovered a myriad of other items that he may be able to sell,
including office furniture, computers, and miscellaneous supplies. The Receiver will make
reasonable efforts to maximize the amount he is able to recover from the possible sale of
these items.

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III.

Marketing Efforts
The Receiver’s marketing efforts for Quest mainly have been through

communications with various individuals with ties to the oil and gas exploration industry to
generate referrals of interested buyers and through communications with potential buyers
familiar with Quest or the Receivership. Those communications, however, resulted in no
meaningful offers. The Receiver sought advice from various individuals with knowledge of
the oil and gas exploration industry in an effort to determine the best way to market Quest for
sale. As a result of those efforts, two potential marketing firms submitted proposals to the
Receiver. After careful consideration, the Receiver determined that selling Quest through a
private sale with the assistance of WhiteHorse Partners, LLC (“WhiteHorse”) is in the best
interest of the Receivership Estate as he believes it provides the best opportunity to market
Quest to the widest audience for the most value.
WhiteHorse is a boutique advisory firm based in Nashville, Tennessee familiar with
the oil and gas industry. It has marketed and sold (or is currently marketing and in the
process of selling) companies similar to Quest. WhiteHorse’s marketing strategy for Quest
will include the following efforts:


a complete review of the documentation related to Quest’s current and past
operations including its current and past accounting databases so consolidated
financial statements can be prepared;



a determination of Quest’s market value;



the development of a marketing plan aimed at locating qualified purchasers;



the preparation of a marketing memorandum which will outline relevant
details about Quest;



the execution of a marketing initiative;

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

the qualification of potential buyers to ensure their financial ability to
conclude a transaction to buy Quest and a review of their prior transactions
and experience with entities such as Quest;



conducting tours of Quest’s properties and speaking with personnel;



the analysis of all offers;



assisting with the negotiation of a letter of intent or purchase offer; and



working on closing the sale transaction, including due diligence.

WhiteHorse has presented the Receiver with a proposed Marketing Engagement
Agreement which seeks a non-refundable $5,000 retainer and a 6% commission of the sale
price of Quest. The $5,000 retainer will be credited at the time of closing. The Receiver
believes the terms in the engagement agreement are fair and reasonable and that retaining
WhiteHorse to market and sell Quest is in the best interest of this Receivership.
On May 14, 2014, the Receiver filed a motion for leave to retain WhiteHorse to
market and sell Quest and/or its assets (Doc. 1115). On May 15, 2014, the Court denied this
motion without prejudice to the motion being renewed (Doc. 1116). The Court denied the
motion because it concluded that the appeal brought by the Downeys divested it of
jurisdiction over this matter while the appeal is pending. As discussed above, the Receiver
has prevailed on appeal. Accordingly, on October 28, 2014, the Receiver filed a renewed
motion for leave to retain WhiteHorse (Doc. 1144).
IV.

Proposed Course of Action
From the Receiver’s investigation, it appears that the oil well leases held by Quest

have potential value and may be able to be sold for the benefit of investors and other
creditors. The Receiver will continue to evaluate the wells and their potential for production

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relative to the expense required to maintain the wells and make them productive. This
activity is intended to generate cash flow while evaluation and liquidation activities are
attempted. The Receiver will continue to work with the RRC to ensure compliance with
regulatory requirements.

The Receiver will evaluate and market leases in an effort to

generate as much value as reasonably possible. While marketing these assets, the Receiver
will continue to operate the business in an effort to preserve and enhance its value. The
Receiver will continue to review financial documents and other documents from the
Company to further his investigation. The Receiver has and will continue to maintain a
separate accounting of revenues and expenses for Quest. He will also continue to consider
all of the information he has gathered to date, additional information he gathers, and the
Company’s or its assets’ prospects and value to determine how to address claims held by
Quest investors and other creditors. At this time, the Receiver contemplates that he will
conduct a separate claims process to deal with the claims of investors and other creditors of
Quest if the sale of Quest’s assets warrants such a process. The Receiver, however, currently
believes that the assets and potential value of Quest is significantly less than the outstanding
balance of investors’ investment amount in Quest.
CONCLUSION
Creditors and investors in the Receivership Entities are encouraged to periodically
check the informational website (www.nadelreceivership.com) for current information
concerning this Receivership. The Receiver and his counsel have received an enormous
amount of emails and telephone inquiries and have had to expend significant resources to
address them. To minimize those expenses, creditors and investors are strongly encouraged

16

to consult the Receiver’s website before contacting the Receiver or his counsel. However, if
you are an investor or creditor of Quest and have not yet provided your email or other contact
information to the Receiver, please contact Jeffrey Rizzo by email to [e-mail]
or telephone [phone].

The Receiver also encourages anyone who may have

information that may be helpful in securing further assets for the Receivership estate or
identifying other potential parties who may have liability to either the Receivership estate or
investors to also contact Mr. Rizzo with that information.
Dated this 4th day of November, 2014.
Respectfully submitted,
s/Burton W. Wiand
Burton W. Wiand, Receiver

CERTIFICATE OF SERVICE
I HEREBY CERTIFY that on November 4, 2014, I electronically filed the
foregoing with the Clerk of the Court by using the CM/ECF system.
s/Gianluca Morello
Gianluca Morello, FBN 034997
[e-mail]
Maya M. Lockwood, FBN 0175481
[e-mail]
WIAND GUERRA KING P.L.
5505 West Gray Street
Tampa, FL 33609
T: [phone]
F: [phone]
Attorneys for the Receiver, Burton W. Wiand

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