Free Receivers Financial Report - District Court of Colorado - Colorado

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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO

Civil Action No. 01-cv-645-JLK SECURITIES AND EXCHANGE COMMISSION Plaintiff, v. KENNETH ROY WEARE a/k/a ROY WEAVER, J&K GLOBAL MARKETING CORPORATION, and AAA-AUCTION.COM, INC., Defendants.

RECEIVER'S THIRD QUARTERLY REPORT FOR THE QUARTER ENDED JUNE 30, 2006

Patten, MacPhee & Associates, Inc., the Court-appointed Receiver in this case, hereby submits this quarterly report outlining in detail the current status and progress of its efforts to establish and administer a claims process for investors, as set forth in the Court's Order Appointing Receiver dated October 26, 2005. For reasons discussed more fully below, the Receiver has experienced significant delay and out-of-pocket expense the past several months as the identification and location of investors have proven to be even more problematic than originally anticipated by the Receiver and, presumably, the SEC. Nevertheless, based on data and other information gathered through that process, the Receiver has reached certain conclusions and preliminary recommendations concerning the claims administration and distribution processes going forward. The Receiver hopes to meet with the SEC by the end of the month, or at the earliest mutually-convenient date, in order

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to discuss these conclusions and preliminary recommendations further and to develop a fair and efficient claims administration process that will meet with both the SEC's and the Court's approval. Toward that end, the Receiver reports the following: 1. On or about April 11, 2001, the SEC filed this civil action against the Defendants for

operating a fraudulent investment scheme over the Internet. According to the SEC's press release issued at that time, the Defendants had offered and sold the J&K Global investment to more than 13,000 investors since at least November 1999. In addition, the AAA-Auction.com investment was described as a "previous fraudulent offering" that operated an Internet auction site in 1998 and 1999. Thus, each investor parted with his/her money a minimum of five and as many as eight years ago. 2. On or about January 8, 2002, the Court entered a permanent injunction by default

against Defendants, finding that they had sold $375 investments in a "rent/mortgage free" program that promised returns of 600% annually from funds purportedly invested offshore. At that time, the Court ordered the disgorgement of profits totaling $6.9 million, prejudgment interest of almost $630,000 and the payment of $330,000 in civil penalties. Later that year, Defendants were found in civil contempt of the Court's orders. In addition, Defendant Weare was indicted by a federal grand jury on March 25, 2003; pled guilty on April 1, 2004; and, was sentenced to 36 months in federal prison on August 3, 2005. At the time of sentencing, Judge Nottingham also ordered Defendant Weare to pay $1,199,355 in restitution to those victims who had responded to a victim survey by the FBI. The press release issued by the United States Attorney's Office at that time claimed that Defendants had defrauded over 23,000 investors with their "Offshore Rent/Mortgage Free Program" and that investors had transmitted more than $9 million to bank accounts in the -2-

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United States, Luxembourg and the West Indies between November 19, 1999 and December 31, 2000. 3. The SEC recovered more than $3 million of those funds for investors. In early

August 2005, the SEC issued a request for proposals ("RFP"), seeking a receiver and distribution agent to establish and administer the claims process for returning the recovered funds to investors. According to the RFP, the SEC was in possession of an Access database containing more than 48,000 records of historical information regarding approximately 23,000 unique investors. It is the Receiver's understanding that the Access database was created by the SEC from a database provided by the Defendants to the SEC in another format. Over time, the SEC had also compiled summaries of many of the Defendants' bank records, including checks written to investors by Defendants and deposit items listing in many, but not all, instances investors' names and identification numbers. Thus, one of the critical tasks to be performed by the proposed receiver and distribution agent was to devise a comprehensive and efficient process for establishing the current location of the approximately 23,000 investors, based on the Access database and other investor information to be provided by the SEC. 4. On September 23, 2005, the Receiver submitted its proposal to the SEC in response

to the RFP. At that time, the Receiver outlined four phases to its proposed scope of work, including (I) Planning/Organization; (II) Investor Contact/Notification; (III) Claims Administration; and, (IV) Distribution to Investors. The Receiver also recommended that an initial attempt to contact all investors be made before reaching specific conclusions or making specific recommendations for the claims administration process. -3-

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5.

In its proposal, the Receiver also provided a good faith estimate of its fees and costs

to perform the work outlined in the RFP, expressly based on the limited information available at that time and the uncertainties inherent in any such claims process. At that time, the Receiver estimated professional fees of $100,000 and out-of-pocket costs for printing, postage and telephone of as much as $20,000. In addition, the Receiver anticipated using the services of MARKITOUTTM, a Louisville, Colorado firm, for broadcast e-mail, website maintenance and database management services. Based upon the limited information provided in the RFP, MARKITOUTTM had estimated its fees and expenses to be approximately $10,000. Thus, the Receiver's total estimated charges for the entire receivership were $130,000, i.e., $100,000 for professional fees and $30,000 for out-ofpocket expenses. 6. In its proposal, the Receiver expressly noted that in estimating its fees and costs, it

was assuming a significant degree of integrity and reliability in the Access database to be provided by the SEC. It also assumed that the database provided valid e-mail addresses for a substantial number of investors. 7. Prior to submitting its proposal, the Receiver was told by the SEC that the database

contained many foreign investors; however, no specific estimate of the number of foreign investors was provided. The Receiver has now determined that more than 7,300 potential claimants included in the Access database reside outside the United States. 8. In general, the Receiver hoped to take advantage of technology to the greatest extent

possible by collecting and validating investor information electronically. Given the large number of investors, including foreign investors, the Receiver recognized that such an approach would

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increase the accuracy of data collected, keep administration expenses low and provide a mechanism to quickly determine and validate each investor's claim. The Receiver also knew that if it were required to input data manually and/or personally interact with more than 23,000 investors, its estimates of the time and costs to complete this project would increase significantly. Consequently, all decisions made and actions taken by the Receiver to date have taken into consideration this critical need for the electronic collection and validation of investor information. The Receiver's preliminary conclusions and proposed recommendations going forward continue to emphasize this need. 9. 10. The Court entered its Order Appointing Receiver on or about October 26, 2005. Since its appointment by the Court, the Receiver has undertaken a number of tasks

to identify and locate investors. Among other things, the Receiver has broadcast more than 60,000 e-mails and has mailed more than 13,300 letters to the persons identified in the Access database provided by the SEC. In addition, the Receiver contracted with MARKITOUTTM to design, create and maintain a website to collect current contact information from investors and communicate with investors going forward. Also, a link was established between the SEC's website and the Receiver's website. 11. The design and implementation of the Receiver's website was complicated, by

necessity, when it was discovered that the nature of the Defendants' fraudulent scheme encouraged many investors to make multiple small investments ­ using variations of their own name and/or the names of family members and friends ­ rather than a single, lump-sum investment. For example, it was discovered that an individual named "John Paul Anderson" might have registered and/or

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invested with Defendants under the names "John Paul Anderson," "John P. Anderson," "J. Paul Anderson" and "J.P. Anderson" in addition to the names of his wife, children, parents and friends. Preliminary analysis of the Access database revealed many such situations. In fact, the Receiver discovered early on that one potential claimant in California was included in the Access database more than 600 times, each time using a slight variation of his/her name or address, although it is unlikely that he made more than 600 investments. 12. In order for the Receiver's website to electronically collect and store information

regarding these multiple investments, the Receiver's costs for database programming and website design have greatly exceeded the original estimate made by MARKITOUTTM. As of the date of this quarterly report, the Receiver has paid approximately $16,000 for such database programming and website design costs, in addition to $9,000 for the broadcast e-mail and other services contemplated by MARKITOUTTM's initial $10,000 estimate. 13. The Receiver's website was completed and tested in early April 2006. On April 6,

2006, the Receiver sent an initial e-mail to a group of 567 investors previously determined to have valid e-mail addresses and who had "opted-in" to receive an e-mail from the Receiver regarding this matter. Of that limited group of interested e-mail recipients, only 344 (61.6%) ever opened the Receiver's e-mail. At the same time, approximately 329 e-mail recipients (58.0%) registered their current contact information at the Receiver's website. Another 75 individuals, presumably "family and friends" of the e-mail recipients, also registered at the website as a result of that initial e-mail. 14. On April 25, 2006, the Receiver sent an e-mail notice of this matter to an additional

22,907 unique and properly formatted e-mail addresses contained in the Access database, asking the

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recipient to register his/her current contact information at the Receiver's website. Over the next several hours, 13,491, or 58.9%, of the e-mails bounced, indicating that those e-mail addresses no longer, if ever, existed. The next day, more than 21,000 e-mails were sent to the same set of e-mail addresses, of which 13,507, or 64.3%, bounced. 15. Of the approximately 24,269 unique entries within the e-mail address field of the

Access database provided by the SEC, only 10,239, or 42.2%, were valid e-mail addresses capable of notifying a potential claimant. Although disappointing, this result was not all that surprising given the length of time that had passed since these e-mail addresses were first provided to Defendants by investors. 16. More surprising has been the response ­ or more accurately, the lack of response ­

by potential claimants who have received e-mail notification from the Receiver. According to reports prepared by IntelliContact, a product division of the Broadwick Corporation, of the 35,486 e-mails actually received at e-mail addresses contained in the Access database, as few as 5,334 (15.0%) were ever opened and in only 2,275 (6.4%) instances did the recipient actually click through to the registration page at the Receiver's website. Moreover, as many as 1,897 recipients of the Receiver's e-mail(s) affirmatively "unsubscribed," thereby notifying the Receiver that he/she does not want to receive any more e-mail communication from the Receiver. 17. The Receiver can only speculate as to the reasons for this relatively meager response

from investors identified in the Access database. However, based on analysis of the database itself, the prior experience of MARKITOUTTM and the Receiver's subsequent conversations with investors, several possible reasons have emerged. First, given the number of years that have passed since these

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e-mail addresses were being used by investors, it is possible that different persons now use some of the e-mail addresses contained in the Access database. In any such case, the e-mail recipient obviously did not invest with Defendants and, therefore, may simply ignore the Receiver's notice. Similarly, some of the individuals identified in the Access database may not have actually invested with Defendants. In fact, the Receiver has heard from a few people indicating that they were aware of the J&K Global investment opportunity and may have provided contact information to Defendants, but did not invest. Others have told the Receiver that they do not recall this specific investment, but lost substantial sums in Internet investments, generally. Still others may have considered the relatively small amount invested and/or the lack of proof of such investment, combined with the likely amount of recovery, to not make it worth their while to participate in the refund process. 18. The Receiver has also been contacted by a number of individuals who have been

reluctant to provide the Receiver with their current contact information because they are concerned that they are being "scammed" once again. In at least one situation, an individual contacted the Receiver, acknowledging that he had tried to "scam" the Defendants by investing multiple times, rather than all at once. That individual told the Receiver that he would forfeit any refund if it meant he were "in trouble" for doing so. Also, it is possible that investors who previously responded to the FBI's victim survey may believe that they have already provided the information being requested. 19. Whatever the reason(s), the fact remains that the more than 24,000 unique e-mail

addresses contained in the Access database resulted in as few as 1,800, approximately 7.5%, of the potential claimants registering their current contact information with the Receiver.

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20.

During the first part of May, the Receiver continued to send follow-up/reminder e-

mails to the valid e-mail addresses that did not register at the Receiver's website or unsubscribe, with similar results. Of the 18,365 total e-mails sent by the Receiver on May 4, May 10 and May 12, 2006, as few as 2,156 (11.7%) were opened and in only 846 (4.6%) instances did the recipient actually click through to the website's registration page. Given the relatively low cost of broadcast e-mails, the Receiver plans to send at least three more e-mails to all valid, but previously nonresponding, e-mail addresses during the month of July and may continue sending such e-mails until a date shortly before the end of the claim period. 21. Shortly after sending its first e-mail, the Receiver learned from an investor of the

existence of at least two Internet forums/bulletin boards at which J&K Global investors periodically posted information regarding the efforts of the SEC and others to bring the Defendants to justice and/ or recover investors' funds. At the request of the Receiver, that investor subsequently posted notice of this action and the need for investors to register their current contact information at the Receiver's website on at least two such Internet forums/bulletin boards. Thus, the Receiver has been advertising notice of this matter on the Internet since April 2006. 22. With respect to the more than 13,000 potential claimants identified with bounced e-

mails, the Receiver used the Access database to create both a US and a foreign postal mailing list. Although importing the data from the Access database to an Excel spreadsheet required little effort, the quality of the data proved to be less than the Receiver had hoped. For example, the Receiver immediately noted missing and clearly inaccurate ZIP codes; addresses where the country, state or province that had been input by Defendants' employees was obviously wrong; and, clearly fictitious

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addresses, such as those of Donald Duck in Hollywood. Significant staff time and professional fees, therefore, were expended in developing accurate and effective mailing lists for those persons identified in the Access database with invalid e-mail addresses. 23. On or about June 9, 2006, the Receiver sent 8,294 letters, via US mail, to potential

claimants in the United States. The letters were identical to the e-mail notices previously sent by the Receiver, notifying recipients of this civil action and requesting that they login and register current contact information at the Receiver's website. Of that number, only 470 addresses (5.7%) were considered non-CASS verified, meaning software used in conjunction with that provided by the US Postal Service could not verify or supply a 9-digit ZIP code for the address. Nevertheless, a 5-digit ZIP code existed for each of those 470 addresses and it is the Receiver's understanding that many of the letters sent to those addresses were, in fact, delivered; however, the Receiver does not know how many or which ones. 24. Since that mailing, the Receiver has obtained through On Target Mailing Services of

Denver a National Change of Address Report, identifying those addresses included in the Receiver's US mailing list for which a change of address card has been filed in the past five years. According to that report, 1,316 moved leaving a forwarding address, 90 moved leaving no forwarding address, 59 closed their post office box and 4 moved to an address outside the United States. Therefore, as many as 1,469 (17.7%) of the 8,294 letters mailed to addresses within the United States may not have reached the intended reader. 25. On or about June 30, 2006, the Receiver mailed 5,069 letters to potential claimants

who reside outside the United States. That mailing went to more than 90 countries, from Albania

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to Zimbabwe. Attached at Exhibit A is a list of the countries to which the Receiver mailed and the number of letters sent to each. As set forth in Exhibit A, countries to which more than 100 letters were sent include Canada (2,053), Australia (967), Germany (423), the United Kingdom (294), the Netherlands (212), New Zealand (179) and Malaysia (148). 26. Postage costs alone related to the above-described mailings totaled $5,754.76. In

addition, the Receiver incurred out-of-pocket costs totaling $2,653.75 for printing, data processing and set-up charges related to the mailings. Therefore, the out-of-pocket cost to date for mailing letters to those potential claimants identified in the Access database, but for whom there is no valid e-mail address, has been $8,408.51. 27. As of June 30, 2006, approximately 2,300 investors had registered their current

contact information at the Receiver's website as a result of receiving an e-mail or postal notice from the Receiver, or some other form of notice from an investor who received notice from the Receiver. 28. As indicated above, the SEC also provided the Receiver with several MS Excel

workbooks, each containing numerous worksheets reflecting detailed monthly banking activity by Defendants. The Receiver has now consolidated the worksheets related to each bank account and combined the resulting worksheets into a single table. That table, which also includes data regarding the money orders seized by the SEC and ultimately deposited into the registry of the Court, currently contains more than 21,000 records. In addition, the Receiver is in the process of adding data related to Canadian bank accounts not previously summarized by the SEC and hopes to receive a report from the SEC and/or the Court's registry identifying which money orders were deposited and which did not clear.

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29.

The Access database provided to the Receiver also included tables of transactions

related to individual investors. In reviewing the transcripts of the testimony of Jeremiah Weaver, a computer programmer retained by the Defendants, the Receiver has learned that the data contained in the transactions data tables may be incomplete or have duplicate entries. Further, based upon the Receiver's review, banking activity independently compiled by the SEC may not include or completely identify all investor-related transactions occurring within a given account. Therefore, the Receiver may be limited in its ability to validate/confirm independently those transactions through either the Access database or the banking records compiled by the SEC. At the same time, some investors' ability to submit proof of payment may be limited by (1) the relatively small size of the investment; (2) the means by which funds were often transmitted to Defendants, e.g., money orders; and, (3) the length of time that has passed since making those investments. 30. In designing its website and written communications to potential claimants, the

Receiver has taken great pains to discourage and minimize one-on-one communications with investors. To assist in those efforts, the Receiver opened both a post office box and a voice-mail account, separate from its other business operations. Nevertheless, the Receiver estimates that it has received as many as 700 e-mails and telephone calls ­ the vast majority of them unsolicited ­ from investors, in addition to written correspondence. The Receiver conservatively estimates that more than $10,000 of the professional fees incurred to date in connection with this receivership are directly related to its need to respond to these communications from investors. 31. The Receiver's fees through June 30, 2006 total $63,032.50 and its out-of-pocket

expenses total $32,924.82. As of the date of this report, the Receiver has sought reimbursement for

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only $36,152.47 of those fees and expenses; however, the Receiver will be filing its Third Application for Fees and Expenses within the next few days, seeking payment of the $35,582.50 in fees and $24,222.35 in out-of-pocket expenses for which it has not previously sought reimbursement from the Court. 32. Based on all of the above, the Receiver has reached certain conclusions and developed

preliminary recommendations to be discussed first with the SEC and then submitted to the Court in the form of a motion concerning (1) further efforts to identify and locate investors; (2) a proposed process and timetable for submission of claims by investors; (3) the level of proof required of investors to support their claims; (4) the methodology to be employed by the Receiver for validating claims; and, (5) any other matters raised by the SEC or the Court's Order Appointing Receiver. Specifically, the Receiver preliminarily proposes, among other things: ! continuing its efforts to contact, by e-mail, those potential claimants who hold valid e-mail addresses provided by the Access database but have not registered current contact information at the Receiver's website, until ten days before the period for submitting claims ends; ! mailing an additional notice to the forwarding address of the 1,316 potential claimants identified in the Access database who, according to the National Change of Address Report recently obtained by the Receiver, have moved within the past five years, as well as any non-CASS verified addresses that may have been corrected by the Receiver's staff since the previous mailing. The Receiver estimates the out-ofpocket expense associated with this effort to be approximately $1,200;

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posting on the Receiver's website, as well as other websites previously identified by the Receiver, a final, urgent notice that failure to register current contact information at the Receiver's website and/or submit a claim form may result in the barring of any claim to a refund;

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not advertising notice of this action in any form of traditional media. It is the Receiver's understanding that the fraudulent investments sold by Defendants were offered over the Internet and not through traditional media. As discussed above, notice of this action has already been advertised at websites frequented by investors. In addition, the Receiver notes that the more popular search engines, e.g., Google, MSN.com and Yahoo, readily direct any person interested in learning more about J&K Global or AAA.Auction.com to both the SEC's and the Receiver's websites. Moreover, given the length of time that has passed since investments were made, the relatively small amount of funds invested by most investors and the worldwide dispersion of those investors, the Receiver seriously doubts whether the benefit derived from traditional advertising would exceed its costs. At the same time, the Receiver notes that such advertising only increases the likelihood of fraudulent claims being submitted, thereby increasing the time and cost of validating claims;

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putting forth additional effort to locate and notify investors in AAA-Auction.com. Given the small number of investors in AAA-Auction.com, fewer than 40, and the dollar amounts invested by each, between $5,000 and $120,000, the Receiver believes that such effort is warranted;

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!

proposing to the SEC and the Court, in the form of a motion, a claims administration time table that includes, among other things, (1) a 60-day claim period; (2) a 45-day period from the claims bar date for the Receiver to allow or disallow claims; (3) the subsequent filing of a report with the Court and notification to all claimants of the allowance or disallowance of each claim; and, (4) a 20-day period for any claimant to appeal to the Receiver the disallowance of his/her claim;

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using software and services provided by FormRouter, Inc. to develop a claims form and process allowing for the electronic completion, submission and limited contemporaneous validation of an investor's claim. In connection with that process, the Receiver anticipates accepting both scanned and hard-copy documents supporting each claim, as well as requiring a signed hard-copy from each claimant;

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requiring the submission of supporting documentation from investors for all claims greater than $375;

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requiring all claimants to discretely identify, to the extent possible, the approximate date and amount of each payment to and from Defendants. In addition, claimants should be specifically asked to identify on whose behalf each transaction was made, if different than the claimant;

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merging the data contained in the consolidated bank table prepared by the Receiver with the transactions table of the Access database in order to identify duplicate entries and, to the extent possible, complete any missing data in each of the databases.

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validating investor claims through a combination of supporting documentation from investors, the transaction table in the Access database and bank records compiled by the SEC. The Receiver's analysis clearly indicates that no single source of data can be relied upon to validate each investor's claim. As noted above, investors' ability to provide supporting documentation may be severely limited here given the length of time that has passed since making those investments and the use of money orders to transmit funds to Defendants. At the same time, the transaction table contained in the Access database appears to be highly suspect given the testimony of Jeremiah Weaver, discussed above, and the fact that the Receiver has already received supporting documents from a handful of investors validating an investment with the Defendants that cannot be associated with any transaction reflected in the Access database. And, as discussed above, the bank records compiled by the SEC is incomplete in some instances, particularly with respect to smaller dollar amounts;

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eliminating consideration of Defendants' payment of $50 referral fees to investors in validating investors' claims; and,

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consolidating all funds recovered by the SEC into a single pool of funds for refunds to both J&K Global and AAA-Auction.com investors. While it may be possible for the Receiver to unravel and separate any commingling of funds and operations between the two fraudulent investment schemes operated by Defendants, the costs of doing so and the equities here favor consolidation.

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As noted above, the Receiver hopes to discuss these and other matters in detail with the SEC by the end of this month, or at the earliest mutually-convenient date. Upon consultation with the SEC, the Receiver's preliminary recommendations set forth above may be further refined or modified. Respectfully submitted this 20th day of July, 2006.

s/ John Paul Anderson John Paul Anderson, MA, CFA Patten, MacPhee & Associates, Inc. 1775 Sherman Street, Suite 2900 Denver, Colorado 80203 Telephone: (303) 296-2900 Fax: (303) 296-4475 E-mail: [email protected]

Dated this 20th day of July, 2006.

s/ Michael D. Burns Michael D. Burns, #11631 1775 Sherman Street, Suite 2900 Denver, Colorado 80203 Telephone: (303) 296-2900 FAX: (303) 296-4475 E-mail: [email protected] Attorney for Receiver

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CERTIFICATE OF SERVICE I hereby certify that on July 20, 2006, I electronically filed the foregoing RECEIVER'S THIRD QUARTERLY REPORT FOR THE QUARTER ENDED JUNE 30, 2006 with the Clerk of the Court using the CM/ECF system, which will send notification of such filing to the following e-mail addresses: Virginia L. Grady [email protected] [email protected] Leslie J. Hughes [email protected] Thomas J. Krysa [email protected] [email protected];[email protected] Marc Milavitz [email protected] Edward A. Pluss [email protected] [email protected] and I certify that I have caused to be mailed a copy of the foregoing to the following non CM/ECF participant (individually and as agent for J&K Global Marketing Corporation and AAAAuction.com, Inc.) via U.S. mail, postage prepaid: Kenneth Weare 84168-198 FCI Terminal Island Federal Correctional Institution 1299 Seaside Avenue Terminal Island, CA 90731

s/ Michael D. Burns Michael D. Burns, #11631 Attorney for Receiver 1775 Sherman Street, Suite 2900 Denver, Colorado 80203 Telephone: (303) 296-2900 FAX: (303) 296-4475 E-mail: [email protected] -18-