United States Securities and Exchange Commission v. Quan et al

Filing 104

MEMORANDUM OPINION AND ORDER denying 84 Defendants' Motion to Withdraw/Disburse/Release Funds (Written Opinion). Signed by Judge Ann D. Montgomery on 02/16/2012. (TLU)

UNITED STATES DISTRICT COURT
DISTRICT OF MINNESOTA
U.S. Securities and Exchange Commission,

)
)
Plaintiff,
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MEMORANDUM OPINION
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AND ORDER
v.
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Civil No. 11-723 ADM/JSM
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Marlon Quan, Acorn Capital
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Group, LLC and Stewardship
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Investment Advisors, LLC,
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Defendants,
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and
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Florene Quan,
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Relief Defendant,
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and
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DZ Bank AG Deutsche
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Zentral-Genossenschaftsbank,
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Frankfurt am Main
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Applicant Intervenor.
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_____________________________________________________________________________
John E. Birkenheier, Esq., and Charles J. Kerstetter, Esq., U.S. Securities and Exchange
Commission, Chicago, IL, on behalf of Plaintiff U.S. Securities and Exchange Commission.
Bruce E. Coolidge, Esq., and Brian R. Michael, Esq., Wilmer Cutler Pickering Hale and Dorr
LLP, Washington, D.C., and Thomas Radio, Esq., Best & Flanagan LLP, Minneapolis, MN, on
behalf of Defendants Marlon Quan; Acorn Capital Group, LLC; and Stewardship Investment
Advisors.
Stephen C. Carlson, Esq., and Hille R. Sheppard, Esq., Sidley Austin LLP, Chicago, IL, on
behalf of Applicant Intervenor DZ Bank AG Deutsche Zentral-Genossenschaftsbank, Frankfurt
am Main.
_____________________________________________________________________________

I. INTRODUCTION
On February 8, 2012, the undersigned United States District Judge heard oral argument
on the motion [Docket No. 84] of Defendants Marlon Quan (“Quan”), Acorn Capital Group,
LLC (“Acorn”), and Stewardship Investment Advisors, LLC (“SIA”) (collectively,
“Defendants”) for the limited release of frozen funds. Defendants seek to use the released funds
to retain counsel and defend Stewardship Credit Arbitrage Fund, LLC (“SCAF”) in a federal
civil action filed in New York. Plaintiff U.S. Securities and Exchange Commission (“SEC”) and
intervenor DZ Bank AG Deutsche Zentral-Genossenschaftsbank, Frankfurt am Main (“DZ
Bank”) oppose the motion. For the reasons set forth below, Defendants’ Motion is denied.
II. BACKGROUND
A.

Defendants and SCAF
Quan is a Connecticut-based money manager. Mem. Opinion & Order, May 3, 2011

[Docket No. 51] (“May 3, 2011 Order”) at 3. He owns and manages SIA, an investment advisor
firm. Id. Acorn is also owned and managed by Quan, and is engaged in the business of making
loans. Id. at 4. SCAF is a domestic hedge fund managed by Quan through SIA. Id. at 3.
B.

Investment Losses
Beginning in approximately 2001, Acorn loaned money to, among other borrowers,

companies controlled by Thomas Petters (the “Petters Entities”). Acorn sold the substantial
majority of the loans it originated to SCAF and to Stewardship Credit Arbitrage Fund, Ltd., a
hedge fund located in Bermuda (the “Offshore Funds”).
In September 2008, Petters was discovered to have orchestrated a massive Ponzi scheme
of nearly $3.5 billion. At the time Petters’ Ponzi scheme collapsed, the Petters Entities had

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allegedly defaulted on over $273 million in principal of loans originated by Acorn. A receiver
was appointed over Petters’ assets, and several of the Petters Entities filed for bankruptcy.
C.

SEC Action, Asset Freeze
On March 24, 2011, the SEC commenced this civil enforcement action (the “SEC

Action”) alleging Defendants violated federal securities laws by making false statements,
misrepresentations, and material omissions to investors regarding the Petters loans. Compl.
[Docket No. 1].
Contemporaneous with the filing of the Complaint, the SEC filed an expedited motion to
appoint a receiver and impose an asset freeze over all Defendants and their assets. The request
was prompted by the SEC’s discovery that Acorn was poised to receive $14 million in settlement
proceeds (the “Settlement Proceeds”) from a settlement with the Petters receiver and Petters
Entities’ bankruptcy estates, and that Quan intended to disburse the Settlement Proceeds in a
manner that would deprive SCAF’s investors of a share of the funds.
The Court imposed a freeze on the Settlement Proceeds to preserve them for Quan’s
allegedly defrauded investors, and denied without prejudice the SEC’s other requested relief.
See May 3, 2011 Order at 10-16.
On July 18, 2011, the SEC stipulated to the release of the Offshore Funds’ share of the
frozen Settlement Proceeds to a liquidator appointed in the Offshore Funds’ insolvency
proceedings in a Bermuda Court. See Order, July 18, 2011 [Docket No. 62]. SCAF’s share of
the Settlement Proceeds remains frozen in a Court registry account (the “Registry Account”).
Defendants have also agreed to deposit into the Registry Account distributions owed to SCAF
from various non-Petters account debtors. Presently, the amount frozen in the Registry Account

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totals approximately $18 million, an increase of $4 million from the amount frozen in March,
2011.
D.

Additional SCAF Litigation
In addition to its involvement in the SEC Action, SCAF has been a party in at least five

civil lawsuits to recover assets or defend against claims filed by third parties. Mem. of Law in
Supp. of Defs.’ Mot. [Docket No. 86] at 5-7. Because Quan continues to be responsible for
managing the business of SCAF, he has overseen efforts by the various law firms litigating these
actions. Id. at 5-7, 10-11. The litigation has been paid for with SCAF’s non-frozen funds and
with funds from interested parties, including the Offshore Funds, DZ Bank, SIA, Acorn, and
Quan himself. Id. at 6-7, 10-11.
In November, 2011, Quan, Acorn, the Offshore Funds, and SCAF were sued by
Northlight Fund, LP (“Northlight”) in federal court in New York for securities violations (the
“Northlight Action”). Northlight alleges it paid $5 million to Quan, Acorn, the Offshore Funds,
and SCAF in exchange for the assignment of two promissory notes owed by R. Esmerian, Inc.
(the “Esmerian Notes”) that had been held by SCAF. Northlight alleges the assigned Esmerian
Notes went into default one month after Northlight purchased them, and that the collateral
securing the notes had been overvalued and repledged to another creditor. Northlight has
consented to an extension of time until February 24, 2012 for SCAF to respond to Northlight’s
Complaint.
E.

Defendants’ Motion
Defendants now bring this motion requesting the limited release of frozen funds to allow

SCAF to retain counsel and defend itself against the Northlight Action. Defendants argue the

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release of the funds is in the best interests of SCAF investors because Northlight will otherwise
obtain a default judgment against SCAF, which would diminish the pro rata amount SCAF’s
investors would receive on their claims and potentially give Northlight priority over SCAF’s
investors. Defendants contend in their unverified memorandum of law that Quan has “very few
personal assets left,” and that “[n]either he nor his companies can fund a defense of the claims
against SCAF.” Id. at 10-11. Defendants further argue there is no danger the funds would be
dissipated, because the Court maintains oversight of the frozen funds and jurisdiction over Quan
and his companies. Additionally, Quan argues the released funds would flow directly to counsel
and he would consent to reasonable controls by the SEC over the litigation. Such proposed
controls could include the SEC’s approval of SCAF’s counsel, of major strategical decisions,
and of settlements.
The SEC opposes Defendants’ motion, arguing SCAF’s investors should not be forced to
pay for the defense costs of one of the entities through which Quan conducted his alleged fraud.
The SEC insists: (1) the frozen funds were obtained through Quan’s fraud, and thus belong to
investors defrauded by Quan and to other legitimate claimants, not to SCAF itself; (2) the funds
will be eroded by defending the Northlight litigation and the numerous other lawsuits that will
inevitably be filed against SCAF; and (3) Quan is not the proper person to oversee the litigation
against SCAF, given the serious allegations of Quan’s misconduct alleged in the SEC Action.
The SEC argues a receiver and stay of litigation over the frozen funds is necessary to
comprehensively resolve the competing claims to the frozen funds, as opposed to determining
parties’ interests in a piecemeal fashion as claims are filed. The SEC is in the process of
obtaining authorization to request such relief.

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DZ Bank filed a motion to intervene [Docket No. 92] that was granted at the hearing.
See Order Granting Mot. to Intervene, Feb. 8, 2012 [Docket No. 102]. DZ Bank argues it was
the primary lender to SCAF, has funded all recovery efforts on behalf of SCAF, and is entitled to
over $12 million of the frozen funds. DZ Bank states it and the Bermuda Liquidator have borne
the litigation expense of recovering assets owed to SCAF and the Offshore Funds. DZ Bank
urges its interest in the frozen funds will be impaired if the funds are released. DZ Bank further
contends a receiver over the frozen funds is not warranted, because there is no danger they will
be dissipated, and because a proper vehicle for disbursing the funds is already in place:
specifically, parties seeking an interest in the funds may file a claim with this Court. DZ Bank
intends to file such a claim in the near future.
III. DISCUSSION
The purpose of an asset freeze is to preserve the status quo by preventing the assets from
being dissipated or diverted. SEC v. Infinity Grp. Co., 212 F.3d 180, 197 (3d Cir. 2000). “Such
relief facilitates the enforcement of any disgorgement remedy which might result from finding at
trial that a violation had occurred.” SEC v. Dowdell, 175 F. Supp. 2d 850, 854 (W.D. Va. 2001).
A district court has the discretion to limit or deny the payment of attorney’s fees from
frozen funds. FTC v. World Wide Factors, Ltd., 882 F.2d 344, 347 (9th Cir. 1989) (noting
courts “regularly have frozen assets and denied attorney fees”); CFTC v. Am. Metals Exch.
Corp., 991 F.2d 71, 79 (3d Cir. 1993) (stating the decision to release frozen funds to pay
attorney’s fees “is entrusted to the discretion of the district court”); SEC v. Private Equity Mgmt.
Grp., Inc., No. CV 09-2901, 2009 WL 2058247, at *2 (C.D. Cal. July 9, 2009) (“[I]t is
undisputed that [a district court] has discretion to forbid or limit payment of attorney’s fees out

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of frozen assets.”). Decisions denying the use of frozen funds to pay attorney’s fees recognize
“the importance of preserving the integrity of disputed assets to ensure that such assets are not
squandered by one party to the potential detriment of another.” FSLIC v. Ferm, 909 F.2d 372,
374 (9th Cir. 1990).
Here, the equities weigh against releasing funds so that Quan may retain counsel for
SCAF in the Northlight Action. First, given the SEC’s serious allegations of fraud by Quan
against his investors, Quan is not the best party to oversee SCAF’s defense of the Northlight
Action. Additionally, if the SEC’s allegations are proven, the frozen funds will belong to
defrauded investors and not to SCAF. Allowing Quan to use the funds for SCAF’s defense in
the Northlight action threatens to dissipate assets potentially belonging to defrauded investors.
Finally, SCAF has been using money sources other than the frozen assets to fund other
litigation it has been involved in, and Defendants have not established that these other funding
sources are no longer available. See Infinity Grp., 212 F.3d at 197 (denying request to pay
attorney’s fees from frozen assets because defendants had access to other funds that had not been
frozen); Am. Metals, 991 F.2d at 79 (denying payment of attorney’s fees from frozen funds
because defendant had access to additional sources of money). Specifically, Defendants have
not shown SCAF no longer has access to: (1) SCAF’s unfrozen assets, (2) funds from Quan and
his companies (whom the SEC argues owe SCAF several million dollars), and (3) resources
provided by interested third parties including DZ Bank and the Bermuda Liquidator.

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IV. CONCLUSION
Based on the foregoing, and all the files, records and proceedings herein, IT IS
HEREBY ORDERED that Defendants’ Motion [Docket No. 84] is DENIED.

BY THE COURT:

s/Ann D. Montgomery
ANN D. MONTGOMERY
U.S. DISTRICT JUDGE
Dated: February 16, 2012.

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