November 2, 2011 8:27 PM
Suit Claims Foley & Lardner Helped Perpetuate $500 Million Ponzi Scheme
Posted by Sara Randazzo
A trustee involved in the Chapter 11 case of bankrupt real estate investment company DBSI Inc. sued Foley & Lardner this week, claiming that the firm played a role in perpetuating what the trustee described as a classic Ponzi scheme that bilked investors out of hundreds of millions of dollars.
The suit—filed Monday in U.S. district court in Delaware by James Zazzali, the trustee for the DBSI estate litigation and private actions trust—alleges that Foley attorneys worked with DBSI principals as early as 2004 to create fraudulent investment and tax structures as part of a $500 million fund designed to attract new investors. The fund ultimately collapsed and DBSI was forced into bankruptcy in 2008.
Founded in 1980, Idaho-based DBSI built its business by acquiring interests in commercial and residential rental properties and selling fractions of its holding to investors as so-called tenants-in-common, according to the Delaware Bankruptcy Litigation blog on the Fox Rothschild Web Site. DBSI managed the properties and took in rent from tenants, passing a portion of the proceeds to investors. By 2004, the trustee's complaint claims, the company had become a Ponzi scheme, sustaining itself only by bringing in new investors to repay the old ones.
The complaint seeks to prevent Foley, "as a key aider and abettor" of the DBSI principals, from "enjoying the fruits of their wrongdoing and to force with them to make good the harm that they caused." The suit includes claims of professional negligence and legal malpractice, fraud, aiding and abetting breaches of fiduciary duty, civil conspiracy, and the payment of fraudulent transfers.
A Foley spokeswoman did not immediately return requests for comment Wednesday.
Zazzali, who is responsible for handling all litigation related to the DBSI estate, is of counsel at Newark, New Jersey–based Gibbons and a former chief justice of the New Jersey Supreme Court. Contacted by The Am Law Daily, Zazzali directed questions to Brian McMahon, chair of the firm's business and commercial litigation group, whom Zazzali said prepared the complaint. McMahon did not respond to a request for comment.
Foley first became involved with DBSI in 2004 and 2005, when it advised the company on a handful of property deals, the complaint says. Over the years, according to the complaint, the scope of Foley's services grew, with the firm advising on tax issues related to the tenants-in-common structure, reviewing real estate purchase contracts, and advising on easement and zoning issues. By the time DBSI was allegedly operating as a Ponzi scheme, the complaint claims, "any competent professional" should have seen that the rate of return promised to investors was not realistic.
Though it does not name him as a defendant, the complaint identifies Stephen Burr, a former Foley partner in Boston, as working most closely with the company. Burr, who left Foley in 2010 for Eckert Seamans Cherin & Mellott, where he chairs the firm's real estate group, did not immediately respond to a request for comment.
By 2006, according to the complaint, DBSI's cash shortages became severe, and by the next year the company became desperate for new properties with which it could lure new investors. Without an adequate supply of developed properties on the market, the complaint claims, DBSI sought to use its joint investment method on undeveloped parcels, asking Foley to create a legal structure to allow the company to purchase and syndicate the land and create incentives for investors.
The result, the complaint alleges, was a land-option structure that provided DBSI with yet another way to rack up obligations to investors that could only be satisfied through additional investment. Despite what the complaint says are hesitations expressed by Burr in July 2007, the plan went forward, with DBSI bringing in $14.3 million on its first undeveloped parcel.
The 53-page complaint (PDF) details a series of other alleged involvements Foley had with DBSI as the company collapsed, including a claim that Burr and other lawyers at the firm encouraged Foley clients to invest in DBSI, reassuring them that the investment offerings were sound "even on the eve of the DBSI Companies's bankruptcy filings."Make a comment