Free Status Report - District Court of California - California

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1 DAVID L. OSIAS (BAR NO. 091287) DEBRA A. RILEY (BAR NO. 151925) 2 TED FATES (BAR NO. 227809) ALLEN MATKINS LECK GAMBLE 3 MALLORY & NATSIS LLP 501 West Broadway, 15th Floor 4 San Diego, California 92101-3541 Phone: (619) 233-1155 5 Fax: (619) 233-1158 E-Mail: dosias@allenmatkins, corn driley@allemnatkins, corn 6 [email protected] 7 Attorneys for Permanent Receiver Thomas F. Lelmon 8 9 10 11 12 SECURITIES AND EXCHANGE COMMISSION, 13 Plaintiff, 14
V.

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA

Case No. 08-CV-0400 DMS (BLM) FIRST INTERIM REPORT OF PERMANENT RECEIVER AND PETITION FOR FURTHER INSTRUCTIONS
[Civil Local Rule 66.1.e]

15 TUCO TRADING, LLC and 16 DOUGLAS G. FREDERICK, 17 18 19 20 21 22 23 24 25 26 27 28
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Defendants.

Date: Time: Ctrm: Judge:

July 18, 2008 1:30 p.m. 10 Hon. Dana M. Sabraw

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1 2 3 4 5 6 7 8 9 [II. 10 W. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
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TABLE OF CONTENTS

INTRODUCTION ...............................................................................................................1 2 OVERVIEW OF TUCO TRADING ................................................................................... A. B. C. D. 2 Co1~orate Structure ................................................................................................. Member Trading Activity ......................................................................................... 2 Coamnissions Earned ............................................................................................... 5 Accounting of Member Balances ............................................................................ 6

6 PROCEDURAL BACKGROUND ..................................................................................... 8 SUMMARY OF RECEIVER'S ACTIVITIES .................................................................... A. B. C. D. E. F. 8 Employment of Professionals ............................................................................. i Securing Tuco Premises ........................................ .................................................. 9 Securing Tuco's Assets ............................................................................................ 9 ¯ 10 Securing Electronic Data ....................................................................................... Winding Down the Business ................................................................................. !0 11 Interviewing Witnesses and Gathering Documents .............................................. 1. 2. 3. 4. 5. 6. 7. 8. 9. G. H. I. Frederick mad Tuco ........................................................................: ...........11 12 Former Employees/Independent Contractors of Tuco .............................. GLB Trading ............................................................................................. 13 13 Other Tuco Broker-Dealers ....................................................................... Penson .................................. .....................................................................14 NYFIX .......................................................................................................14 Alchemy Ventures, LLC ........................................................................... 14 14 Certain Tuco Members .............................................................................. 15 Certain Tuco Creditors ...............................................................................

15 Filing the Judgment in Other Jurisdictions ........................................................... Tuco Website .........................................................................................................15 16 Communications with Members and Creditors .....................................................

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 VI. 16 VII. B.
go

16 INVENTORY OF ASSETS .............................................................................................. A. 17 Investigation of Assets ............................... ........................................................... 1. 2. 3. 4. GLB Trading Receivable .......................................................................... 17 18 NYFIX Charges ......................................................................................... 19 Penson Interest Charges ............................................................................
o

T3 Ownership Interest ............. .................................................................. 19

19 Investigation of Payments ..................................................................................... 1. 2. 3. 4. 5. 6. 19 GLB Deductions ........................................................................................ 20 Schiller/Southwest Securities .................................................................... 20 Halperin/Marquis Jet Partners ................................................................... Jonathan Iqirkland .............................................................. ....................... 21 21 Michael Kestler ......................................................................................... 21 Lisa Hyatt/Kayo Financial., .......................................................................

22 SHORTFALL ANALYSIS ............................................................................................... 22 RECEIPTS AND DISBURSEMENTS .............................................................................

23 17 VIII. CREDITORS AND CLAIM AMOUNTS ........................................................................ 18 IX. 19 X. 20 21 22 23 24 25 26 27 28
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23 PENDING AND POTENTIAL LITIGATION ................................................................. 24 CONTINUING ACTIVITY .................................................. : ...........................................

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1

Thomas F. Lennon ("Receiver"), Court-appointed permanent receiver for Tuco Trading,

2 LLC .("Tuco"), hereby reports on his efforts to date and the status of his investigation, and 3 petitions the Court for further instructions pursuant to Civil Local Rule 66.1.e, and this Court's 4 Order in Aid of Receivership entered on March 19, 2007. Attached hereto as Exhibit A and 5 discussed herein is the Receiver's preliminary accounting of Tuco ("Preliminary Accounting"). 6 The volume of material and information acquired, the shortness oftime between receipt of

7 material information and the report, the complexity of the matters analyzed and the need for 8 additional information, verification and analysis requires that this report be considered preliminary 9 only; the Receiver may need to materially modify its contentS after further investigation and 10 consideration. 11 12 I. INTRODUCTION

The Receiver's duties, responsibilities and activities fall generally into four categories:

13 (1) securing, protecting and recovering assets; (2) investigating the who, when, how and why of 14 the basis for the receivership proceedings; (3) analyzing and developing, with Court approval, an 15 equitable approach for distribution of assets and losses to investors and creditors; and (4) the 16 liquidation of assets and the review and allowance of claims against the receivership estate. This 17 report touches on each of these four categories in varying detail and degree in relation to the focus 18 of the Receiver during the first 75 days of this case. 19 The Receiver and his professionals have worked diligently to carry out the tasks and

20 responsibilities of the Receiver with a consistent effort to minimize administrative expenses. As 21 part of that effort, the Receiver has sought documents and witness statements on an informal 22 consensual basis so far, rather than expending additional resources on document subpoenas and 23 depositions. As discussed below, certain information has been produced in a prompt and 24 cooperative fashion, while other information has taken longer to obtain. As documents, data and 25 witness statements are obtained and reviewed, the Receiver has assessed whether the information 26 is sufficient mad reliable or additional investigation is warranted. The Receiver has not yet used 27 the subpoena power granted to him, but doing so may become necessary as his investigation 28 continues.
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1 2

II.

OVERVIEW OF TUCO TRADING

On August 14, 2006, Douglas Frederick ("Frederick") formed Tuco Trading, LLC. On or

3 about November 1, 2006, Tuco acquired a day trading finn called Evolution Capital, LLC 4 ("Evolution"). Evolution had been owned and managed by Jonathan I~drkland and Michael 5 Kestler. Frederick had worked as a consultant for Evolution. 6 7 A. Corporate Structure

Tuco is a Nevada limited liability company. Tuco's structure consists of class A members,

8 whom are described in the Tuco Operating Agreement as "Owner-Members", and class B 9 members, whom as described as "Traders." Under the Operating Agreement, a copy of which is 10 included in Exhibit 5 to the Declaration of Robert A. Tercero in Support of the SEC's Ex Parte 11 Motion for TRO, the class A members had voting fights, including the ability to elect "Managers" 12 of the company. Managers were vested with the authority to manage, control and operate the 13 company. Frederick was the only class A member and Manager ofTuco.1 14 15 B. Member Trading Activi ,ty

The traders, or class B members, are referred to herein as "Members." Members did not

16 have voting or management rights within the company. 17 Tuco did not operate as a brokerage finn that traded securities on behalf of its clients.

18 Rather, Tuc0 made trading software platforms available to its Members, allowed its Members to 19 place trade orders through its brokerage accounts, and, for a small number of Members, provided 20 office space at which they conducted their trading activities. Tuco allowed its Members to trade 21 with greater leverage and with less money than they could trade if they opened their own 22 brokerage accounts with a broker-dealer. Tuco allowed its Members to trade with buying power 23 between 6:1 and 20:1,2 as opposed to the 4:1 limit for standard brokerage accounts. Frederick 24 25 26 27 28
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Michael Kestler, who had been a managing member of Evolution, was listed as a class A member of Tuco on the 2006 Tuco federal tax return. According to Frederick, this was a mistake made by the accountant that prepared the return. Mr. Kestler is not listed as a class A member under the Tuco Operating Agreement. Additionally, as discussed further below, Lisa Hyatt and/or her entity Kayo Financial invested in Tuco as a class A member. The investment was later recharacterized as a loan and repaid to Ms. Hyatt by Tuco. By way of example, 6:1 buying power means that the Member could place trade an order of $6 for every $1 dollar in his or her Member account.
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1 determined each Member's buying power based on, among other things, his or her account 2 balance, trading experience and trading volume. Tuco also allowed its Members to open an 3 account with only $10,000 (and sometimes even less), whereas $25,000 is the minimum required 4 for standard brokerage accounts. 5 As discussed .on page 2 of the Preliminary Accounting, each Member completed a new

6 account package when they opened an account with Tuco. The new account materials do not state 7 the tenr~s on which the Members were allowed to trade. Rather, the Members made oral 8 arrangements with Frederick regarding the cormnissions Tuco would charge them and the buying 9 power at which Tuco would allow them to trade,3 10 As discussed on page 3 of the Preliminary Accounting, there were three types of Member

11 accounts at Tuco: 12 13 1) Single Members Accounts in which one Member traded using one account with Tuco; 2) Master Member Accounts in which one Member traded using multiple accounts with

14 Tuco, which accounts were aggregated as one combined account balance; and 15 3) Member Accounts with Sub,Accounts in which one entity~Member had one account

16 with Tuco that was used by numerous individual traders associated with the entity, The individual 17 traders associated with the entity would place trade orders through the entity's account with Tuco. 18 Examples of these discussed below are Members Lanai, Ltd. ("Lanai") and T3 Capital, LLC 19 ("T3"). Tuco treated these entities each as one Member with one account balance derived from 20 the collective deposits, withdrawals, trading activity, fees and Co~mriissions of the individual 21 traders associated with the entity. 22 An account at one of several trading software platforms ("Trading Platforms") used by

23 Tuco was created for each Member. The Trading Platforms provided the Members with access to 24 the securities markets. Tuco had rights to all Member accounts at the Trading Platforms. 25 Pursuant to the oral arrangement between the Member and Frederick, Tuco would set the 26 27 28
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Tuco did not maintain records reflecting the co~mnission rate for to each Member. However, the Titans System used to track Member accounts (discussed below) reflects the volume of shares traded and the co~mriissions charged to each Member's account~ Furthermore, there are no records of Member complaints regarding commissions, nor has the Receiver received any such complaints.
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1 Commission rate and buying power available to each Member through the Trading Platforms. 2 Tuco could also set certain risk parmneters for its Members for use of the Trading Platforms, 3 including a daily loss threshold at which the Member's ability to place trade orders would be 4 terminated for that day. Frederick, Mr. Kestler and certain of Tuco's employees would supposedly 5 monitor Member trading accounts in real time and contact the Member regarding significant 6 losses. As discussed on page 4 of the Preliminary Accounting, the number of negative Member 7 account balances shows that this monitoring either did not occur or was ineffective. Schedules 8 listing the negative Member account balances as of December 31, 2006, December 31, 2007, 9 March 5, 2008 and May 5, 2008 are attached to the Preliminary Accounting as Exhibits XIV A-D 10 respectively. 11 Under the Operating Agreement, profits obtained and losses incurred from the trading

12 activities of each Member were allocated entirely to the Member. Tuco did not receive any 13 portion of Member trading profits. If a Member's trading losses resulted in a negative account 14 balance, the Member was not allowed to place trade orders through Tuco until the account was 15 restored to a positive balance. Tuco did not have a right to payment from Members for negative 16 balances, however. As noted on Exl~bit XIV D to the Preliminary Accounting, negative Member 17 account balances totaled $1,849,654.15 as of May 5, 2008. 18 The majority of the Members would place trade orders through Tuco's accounts at its

19 primary broker-dealer, GLB Trading,. Inc. ("GLB"). A small number of Members used Tuco's 20 accounts at other broker-dealers, such as ViewTrade. GLB and ViewTrade used Penson Financial 21 Services ("Penson") as the clearing broker for all trades orders placed by Tuco's Members. 22 Tuco's main offices were located at 909 Prospect Street, Suite 224, La Jolla, California (the 23 "Tuco Premises"). Tuco also subleased space in Chicago, Illinois4 and Dallas, Texas. Only a 24' small number of Tuco's Members conducted their trading activities at office space provided by 25 Tuco. The majority of the Members traded remotely from other locations, including locations 26 27 28
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4

The Chicago office space was subleased fTO1TI GLB.
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1 outside the United States.5 Tuco hosted a Internet virtual "chat room" for its Members in which all 2 Members could discuss stocks, trades and related issues in real time. 3 4 C. Commissions Earned

Tuco's primary source of income wds co~rnr~issions earned fi'om the trading activities of its

5 Members. Tuco also earned commissions for referring traders directly to GLB. The trading 6 co~muissions and referral co~mnissions are collectively referred to herein as "Comlrfissions." The 7 Commissions would be recorded by the Trading Platfonr~s and reported to Penson. Penson would 8 collect the Colrnuissions directly from the Tuco accounts at Penson and, after deducting certain 9 industry fees mad charges, pay them to GLB. GLB would then deduct other fees and charges, 10 including its own legal fees and costs (discussed further below), and pay the net Comrnission 11 amount to Frederick as the registered representative of Tuco. Frederick would deposit the 12 Cormrfission amounts received fi'om GLB into Tuco accounts. 13 Frederick's Commissions increased draiuatically in November 2007, due primarily to the

14 increase trading volume of Members Lanai and T3. As discussed on page 4 of the Preliminary 15 Accounting, trading volume in Tuco's accounts had been at approximately 400 million shares per 16 month. In November and December 2007, that amount jumped to approximately 2 billion shares 17 per month and remained at that level until trading halted on March 6, 2008. 18 A substantial amount of the increased Colmnissions, however, were passed on to Member

19 T3. T3 had a'unique relationship with Tuco in that Tuco did not charge it any Commissions for 20 trading activities. T3 charged its own individual traders commissions. These colmrdssions would 21 be collected by Penson, paid to GLB, and in tuna, paid to Frederick. Frederick would then forward 22 that amount to T3. Tuco benefited from T3's trading activity, however, in that T3's large trading 23 volume allowed Tuco to obtain lower rates from Lightspeed, the Trading Platfonu used by T3 and 24 other Tuco Members. Tuco also may own a 10% interest in T3 (discussed further below). 25 As the trading volume in the Tuco accounts with GLB increased, the delay in receiving

26 Co~mnission reconciliation statements from GLB grew. As of about September 2007, and from 27 28
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Sigufificantly, the Receiver understands that Members Lanai and Blackhawk Trading are headquartered in China, and Members Coper Trading and Serafin Group are headquartered in Canada.
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1 that point forward, it took GLB approximately 90 days to provide Commission reconciliation 2 statements. During this period, GLB would often make several interim and partial Commission 3 payments while the Commission reconciliation statements were pending. 4 5 D. Accounting of Member Balances

Tuco used custom-designed software to track its Members' deposits, withdrawals, trading

6 profits and losses, fees and commissions (the "Titans System"). Eacl~ Member had an account in 7 the Titans System that would automatically update on a daily basis with trading activity, fees and 8 Co~mnissions recorded by the Trading Platfonus and co~mnunicated to the Titans System. Tuco 9 wouid also update the Titans System manually with Member deposits, withdrawals and other fees 10 not reported by the Trading Platfomls, including those reported later in the Commission 11 reconciliation statements provided by GLB. Tuco had servers located in La Jolla and Dallas that 12 supported the Titans System. 13 14 III. PROCEDURAL BACKGROUND On March 4, 2008, the Securities and Exchange Co~mnission ("SEC") filed its Complaint

15 and Ex Parte Motion for Temporary Restraining Order and Orders: (1) Freezing Assets; 16 (2) Appointing a Temporary Receiver; (3) Requiring Accountings; (4) Prohibiting the Destruction 17 of Documents, (5) Granting Expedited Discovery; and (6) Order to Show Cause re Preliminary 18 Injunction and Appointment of a Permanent Receiver. On March 5, 2008, the Court issued a 19 Temporary Restraining Order and Orders: (1) Appointing a Temporary Receiver; (2) Requiring 20 Accountings; (3) Prohibiting the Destruction of Documents, (4) Granting Expedited Discovery; 21 and (5) Order to Show Cause re Preliminary Injunction and Appointment of a Permanent Receiver 22 ("TRO"). The Receiver, the SEC and the Defendants sought clarification of the TRO, which was 23 provided in the Court's Supplement to the TRO ("Supplement"), entered on March 6, 2008. 24 The TRO and Supplement appointed the Receiver as temporary receiver with limited

25 powers. The Receiver was granted access to the company, but Tuco was permitted to continue 26 operations in the ordinary course of business. The Supplement also restricted the ability of 27 Members to withdraw funds. 28
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1

On March 6, 2008, trading activity at Tuco was halted when Penson terminated clearing

2 service to Tuco's main broker accounts. Members were only penrfitted to issue liquidating orders 3 from that point forward. The Court held telephonic hearings on March 7 and March 10, 2008 to 4 address this change in circumstances. At those hearings, it was detenrfined that Tuco could 5 continue to operate on a limited basis until the Receiver could provide an initial accounting mad 6 the parties could brief the Order to Show Cause re Preliminary Injunction. 7 On March 11, 2008, Douglas Frederick and Tuco filed financial statements as required

8 under the TRO and Supplement ("Finmacial Statelaaents"). On March 14, 2008, the SEC filed the 9 Consents of Tuco and Frederick, and a Joint Motion for Judgment as to Defendants Tuco and 10 Frederick and Orders: (1) Freezing Tuco's Assets, (2) Appointing a Permanent Receiver for Tuco; 11 and (3) Prohibiting the Destruction of Documents ("Judgment"). The Court entered the Judgnaaent 12 on March 17, 2008. 13 On March 19, 2008, in response to the Receiver's application, the Court entered an Order

14 in Aid of Receivership: (1) Allowing Notice by Email to Members; (2) Providing that 15 Commissions Earned or Payable to Frederick are Property of the Receivership Estate; 16 (3) Authorizing the Receiver to Enter into a Temporary Transaction with GLB Trading, Inc.; and 17 (4) Granting Ancillary Relief ("Order in Aid"). The Order in Aid provides, mnong other things, 18 that the Receiver's initial report may be filed in conjunction with the accounting due under Part 19 VIII.E. of the Judgment, and that interim reports shall be filed by the Receiver approximately 20 every 120 days thereafter. 21 On May 1, 2008, the Receiver applied for approval of a sale of Tuco's office furniture and

22 equipment to Frederick for $21,000. The Court entered an order approving the sale on May 5, 23 2008. 24 On May 15, 2008, new counsel representing Frederick filed a Stipulation for Substitution

25 of Counsel ("Stipulation"). The Stipulation states that Frederick's new counsel is substituted as 26 counsel of record for Tuco mad Frederick. With the assistance of Allen Matkins, the Receiver 27 contacted Frederick's new counsel and advised that Frederick's former counsel was not employed 28
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1 by the Receiver or Tuco at any time after entry of the Judgment. The Stipulation is therefore 2 improper to the extent that Frederick's new counsel purports to represent Tuco. 3 On May 19, 2008, new counsel for Frederick, again purporting to represent Tuco, filed a

4 Notice of Appeal of the Judgment ("Notice of Appeal"). On May 29, 2008, the Ninth Circuit 5 Court of Appeals issued a Time Schedule Order for the appeal that was entered on this Court's 6 docket. As of the filing of this report, Frederick has not sought a stay of the Judgment pending 7 appeal or filed any other motions with the Court of Appeals. 8 9 IV. SUMMARY OF RECEIVER'S ACTIVITIES

The Judgment grants broad relief, including a permanent injunction, a freeze of all assets

10 of Tuco, the permanent appointment of the Receiver with full powers of an equity receiver, a stay 11 of all actions against Tuco, an authorization for the Receiver to investigate the assets of Tuco, 12 including claims and causes of action, and an order requiring that Tuco and Frederick pay the 13 costs of the Receiver and his professionals. As discussed further below, the Receiver has taken 14 steps to implement and enforce the Judgment, including employing professionals, securing Tuco's 15 assets, opening and managing receivership bmxk accounts, securing electronic data, winding down 16 the business, interviewing witnesses and gathering documents, recording the Judgment in the 17 appropriate judi.cial districts, and disseminating information about the Judgment and the case to. 18 Members and creditors. 19 20 A. Employment of Professionals

Pursuant to the authority granted to him under Part VIII.G. of the Judgment, the Receiver

21 has employed Allen Matkins Leck Gmr~ble Mallow & Natsis, LLP ("Allen Matkins") as his 22 general receivership counsel in this matter. Further, the Receiver has employed William H. Ling, 23 CPA ("Ling") to assist in his forensic accom~ting. Finally, the Receiver has employed 24 Investigative Tectmologies ("IT") as his information and tectmology consultant to assist in the 25 investigation, preservation and analysis of electronic data. Allen Matkins, Ling and IT have 26 assisted the Receiver in all phases of this matter, including in preparation for and during his 27 appointment as temporary receiver. 28
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B.

Securing Tuco Premises

hmnediately after his appointment, the Receiver took control of the Tuco Premises. The

3 Receiver determined that it was in the best interest of the estate and its creditors to maintain the 4 Tuco Premises for a short period to allow for (a) the Tuco employees and independent contractors 5 to provide information needed for the Receiver's accounting, (b) IT to do its investigation, 6 preservation mad analysis of electronic data, (c) the Tuco employees to assist the Receiver in the 7 liquidation of open positions mad reconciliation of the stone to the Titans System, (d) the Receiver 8 to invemory, obtain an appraisal of, mad, with Court permission, sell Tuco's office furniture and 9 equipment, and (e) the Receiver to give sufficient notice to the landlord of the termination of the 10 lease. The Receiver terminated the lease effective May 10, 2008. The landlord secured a 11 replacement tenant to move in. promptly thereafter, thus eliminating any lease termination claim by 12 the landlord. 13 Tuco also sub-leased office space in Chicago and Dallas. Those leases were terminated by

14 the Receiver in April and May 2008 respectively. 15 16 C. Securing Tuco's Assets

With respect to the cash assets of Tuco, the Receiver opened an interest-bearing, money

17 market account at California Bank &Trust for the receivership estate, closed the bank and broker 18 accounts of Tuco, and had the balances wired to the receivership account. The Receiver has also 19 instructed Tuco's broker-dealers, GLB, ViewTrade, Wedbushl Advantage Futures, Mann Financial 20 and MB Trading Futures to direct any and all amounts payable to Frederick or Tuco to the 21 Receiver. 22 As noted above, the Receiver also secured the Tuco Premises, including the furniture mad

23 equipmentlocated therein. The sale of the furniture and equipment to Frederick for $21,000 was 24 approved by order entered on May 5, 2008 ("Sale Order"). Frederick has not yet paid the $21,000 .25 due under the sale agreement and Sale Order. The Receiver will pursue recovery of these funds 26 from Frederick and seek relief from the Court as necessary. 27 28
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1 2

D.

Securing Electronic Data

As noted above, Tuco had servers located in La Jolla and Dallas that supported the Titans

3 System. Tuco also had a website supported by a server in La Jolla. IT took an initial and final 4 image of the servers supporting the Titans System. IT also imaged the website server. These 5 servers were all wiped (i.e. all data erased) before being turned over to Frederick in connection 6 with the sale. 7 In response to certain Member inquiries, IT conducted an investigation of the Titans

8 System mad certain Member accounts. IT did not identify any problems with the manner in which 9 the Titans System was operating or its ability to receive mad properly record data transmitted from 10 the Trading Platforms. As discussed in the Preliminary Accounting, however, the Receiver and 11 Ling have thus far been unable to reconcile the aggregate profit and loss from trading activity 12 reflected in the Titans System with the aggregate profit and loss derived from the Tuco brokerage 13 account statements. 14 15 E. Winding Down the Business

On March 5, 2008, when the Receiver was initially appointed as temporary receiver with

16 limited powers, Tuco was an operating day trading firm. This changed almost ilr~r~ediately when 17 clearing services to Tuco's main accounts were terminated by Penson. Tuco received a lrmrgin call6 on February 29, 2008. Tuco historically covered this margin 18 19 call with a weeldy loan from Frank McDonald or one of his entities ("McDonald"). The amount 20 loaned by McDonald would be transferred at McDonald's instruction from his accounts at Penson 21 to the Tuco accounts at Penson, thereby restoring the Tuco accounts to the required 4:1 ratio. 22 Penson was aware of the SEC's intention to COlrnnence an action against Tuco,and

23 Frederick before the action was COlnmenced. McDonald was not aware of the SEC's impending 24 action, however. The weekly McDonald loan that Tuco would have received on March 3, 2008 25 was therefore disallowed by Penson. As a result, Tuco did not meet the February 29 margin call. 26 27 28
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A "margin call" occurs when a trader exceeds the 4:1 leverage or "buying power" for its brokerage account, ha response to a margin call, the trader must deposit additional funds into its account in order to restore the account to the required 4:1 ratio. If the trader fails to do so, the clearing broker generally will lend money to the account on a temporary basis and charge interest on the loan to the trader.
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1 On March 6, 2008, the morning after the Receiver was appointed as temporary receiver, Penson 2 terminated clearing services to Tuco's main accounts. Tuco's Members Were only permitted to 3 liquidate open positions from that point on. All trade orders placed by Members between 4 February 29 and March 6 were placed into an "error account" by Penson. 5 The liquidation of open positions by Members continued for several weeks until the

6 Receiver instructed the Members to liquidate may remaining open positions within a specific 7 period of time. Penson worked to manually reconcile individual trades in the error account. 8 Because the reconciliation of these trades was not done in the ordinary automated fashion, it was 9 not co~rnr~unicated to the Titans System via the Trading Platforms. Therefore, the Receiver 10 worked to reconcile and update tlae Titans System with the trade reconciliation work being done 11 by Penson. This process took approximately a month. With the accounts finally settled, Penson 12 wired all but $300,000 of the Tuco account balances to the Receiver on May 15, 2008. The 13 amount withheld is discussed below. 14 15 F. Interviewin~ WitneSses and Gatherkng Documents

The Receiver, with tl~e assistance of Allen Matldns, Ling and IT, has interviewed and

16 obtained documents from the following persons and entities: 17 18 1. Frederick mad Tuco

During the week following his initial appointment as temporary receiver, the Receiver and

19 his professionals met with Frederick and his former counsel, Michele Fron and Audette Morales of 20 the Keesal Young & Logan law firm. The Receiver team interviewed Frederick at length over 21 approximately 5 days regarding Tuco's operations, its structure, its Members, its relationships with 22 its broker-dealers, Penson and its Trading Platforms, its assets and liabilities, and certain specific 23 transactions. The Receiver, Ling and Allen Matldns have conducted numerous follow-up 24 interviews of Frederick regarding various accounting issues, Member and creditor issues, specific 25 transactions, accounts receivable mad payable, and other matters. Frederick has been cooperative 26 consistently responded to questions directly from the Receiver and his professionals in a prompt 27 and forthcoming manner. Frederick has made himself available to answer questions at almost any 28 time of day, any day during the week.
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1

Frederick has also made substantial efforts to produce documents promptly. He has been

2 hindered in this regard, however, by his mad Tuc0's failure to create docuinents, maimain records 3 and sufficiently organize their business dealings and affairs. As discussed in the Preliminary 4 Accounting, Tuco's books mad records were in very poor condition. Additionally, the limited files 5 kept by Tuco were mostly out of date. As a result, the Receiver has sometimes had to obtain 6 records from third parties that Frederick and Tuco should have maintained. Some records that 7 should have been created, apparently were not. The lack of documentation kept by Frederick and 8 Tuco has delayed the Receiver's investigation mad accounting, and forced the Receiver to incur 9 fees and costs to obtain missing records or piece together an analysis from oral statements mad 10 existing records. 11 12 2. Former Employees/Independent Contractors of Tuco

On March 6, 2008, the Receiver mad his professionals met with Tuco former employee

13 Adam Korsin, and former independent contractors Jarrod Vrazel and Mike Kestler to discuss the 14 Receiver's appointment and the terms of the TRO and Supplement. Former employee Benjamin 15 Ball (on vacation at the time), former independent contractor Yuan Tai Lee and former employee 16 Chi-Shiuan Lu (both located at the Tuco offices in Dallas) were reached by telephone and advised 17 of the same. From that point forward, the Receiver, Ling and Allen Matldns spoke with 18 Mr. Korsin, Mr. Vrazel and Mr. Ball on numerous occasions to discuss trading and accounting 19 matters, and certain Member issues. Additionally, IT met with Mr. Vrazel and Mr. Lee on several 20 occasions to discuss the Titans Systems, Tuco's servers, certain Member accounts and other 21 electronic data issues. 22 Although no document requests were issued to the employees and independent contractors,

23 Mr. Vrazel, Mr. Korsin, Mr. Ball and Mr. Lee were asked to assist the Receiver, in varying 24 capacities. The tasks included allocating fees and charges reported by Tuco's broker-dealers to the 25 Member accounts, reconciling trades in the error account and the liquidation of open positions to 26 the Melnber accounts, making appropriate adjustments in the Titans System, and generating 27 Member account reports from the Titans System for specific time periods. The employees and 28 independent contractors were paid by the Receiver for their time at their pre-receivership rates of
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1 compensation. The employees and independent contractors were terminated effective May 10, 2 2008. Their final paychecks included two weeks severance and a cash out of unused vacation 3 hours. To the best of the Receiver's loaowledge, there are no employee claims against Tuco. 4 5 3. GLB Trading

In the first few weeks following l~s appointment as temporary receiver, the Receiver, Ling

6 and Allen Matkins spoke briefly to Gus Katsafaros mad Bob Lecl~nan, principals of GLB Trading, 7 on several different occasions. In or about mid-March, Allen Matkins was directed to 8 colmnunicate with counsel for GLB located in Chicago. GLB's counsel subsequently instructed 9 the Receiver and Ling to communicate only with him and not directly with anyone at GLB.. GLB 10 counsel later instructed Frederick not to cormnunicate with him mad only to have his counsel 11 communicate with him. After several requests, All'en Matldns was permitted to interview 12 Mr. Katsafaros briefly regarding the Penson interest charges discussed below. The inability to 13 comlnunicate directly with Mr. Katsafaros, Mr. Lechinan and others at GLB has delayed the 14 process of obtaining infonr~ation mad increased administrative expenses. 15 GLB has generally been slow to respond to document requests, including Colmnission

16 reconciliation statements for the months of January, February and March 2008. This has 17 historically been the case with GLB. As noted above, it has generally taken GLB approximately 18 90 days to produce Commission reconciliation statements over the last 9 months, requiring Tuco 19 to go back and allocate fees and charges reported in the statement to its Members well after they 20 were incurred. Nevertheless, GLB has produced these Colrnnission reconciliation statements,7 as 21 well as spreadsheets regarding the outstanding Penson interest charges, statements for Evolution 22 accounts with GLB, and documems.pertaining to the FINRA Proceeding (discussed below). 23 24 4. Other Tuco Broker-Dealers

The Receiver requested Tuco account statements and related documents from broker-

25 dealers ViewTrade, Wedbush, Advantage Futures, Mama Financial and MB Trading Futures. 26 These broker-dealers all promptly responded and provided the requested documents. 27 28 7
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On May 23, 2006, GLB produced the March 2008 reconciliation statement. No Commission payment for March 2008 has been received as of the date of this report, however.
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1 2

5.

Penson

In the weeks following his appointment, the Receiver, Allen Matkins and Ling participated

3 in several telephone calls with Tim Davis, Associate General Counsel at Penson. Mr. Davis 4 provided limited information regarding the February 29 margin call and subsequent events leading 5 up to Penson's termination of clearing services. Mr. Davis also communicated on a limited basis 6 with Allen Matkins regarding the loss amount claimed by Penson in com~ection with the 7 liquidation of open positions (discussed below). Thereafter, Mr. Davis advised the Receiver and 8 counsel to commm~_icate only with Penson's outside counsel. Through its outside counsel, Penson 9 has produced documentation regarding the outstanding interest charges (also discussed below). 10 The Receiver has requested additional infomaation on these charges as well as the loss amount 11 claimed by Penson. Such information has not been received to date. Accordingly, the Receiver's 12 investigation into and efforts to resolve these issues with Penson are ongoing. 13 14 6. NYFIX

With the assistance of Allen Matkins, the Receiver contacted Paul Fitzpatrick and Brian

15 Carr at NYFIX to discuss charges, assessed by NYFIX that Tuco has been unable to allocate to its 16 Members. These charges are discussed further below. Subsequently, Allen Matkins was 17 contacted by Richard Bassler, Senior Legal Counsel for NYFIX. Mr. Carr and Mr. Bassler stated 18 that NYFIX is unable to produce additional information regarding the charges at issue. 19 20 7. Alchemy Ventures, LLC

With the assistance of Allen Matldns, the Receiver contacted Mark Rogers of Alchemy

21 Ventures, LLC ("Alchemy") to discuss certain short-term loans that Alchemy made to Tuco. 22 Mr. Rogers was forthcoming with information about the loans, which were arranged by Gus 23 Katsafaros of GLB. Alchemy promptly produced records showing the transfers from its account 24 at Penson to Tuco's account at Penson. The Receiver has requested written communications from 25 Alchemy regarding the loans, which Mr. Rogers has agreed to provide. 26 27 8. Certain Tuco Members

As noted below, the Receiver, his staff and Allen Matkins have spoken to and responded to

28 emails from numerous Tuco Members. Significantly, Allen Matldns has discussed trading activity
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1 mad Tuco account issues with Member David Halperin and counsel for Members Lanai and T3. 2 Allen Matkins has also spoken to attorneys representing Members Kevin Wojtowicz, I~er 3 Robinson and HG Trading, LLC. 4 5 9. Certain Tuco Creditors

Promptly after his appointment as permanent receiver, the Receiver sent letters to all

6 known creditors advising them to deal with him directly regarding all Tuco matters. The Receiver 7 also directed the Trading Platforms to terminate services to Tuco. 8 The Receiver and Allen Matkins have co~mnunicated with creditor Lightspeed, both

9 directly and through its counsel, regarding the amounts claimed to be owed by Lightspeed and . 10 certain issues regarding the termination of the Lightspeed Trading Platform service. The Receiver 11 requested that Lightspeed produce documents pertaining to the Schiller/Southwest Securities 12 trading activity discussed below. Lightspeed promptly produced the requested documents. 13 The Receiver and Allen Matkins have also co~mnunicated with counsel for the landlord for

14 the Tuco Premises, Prospect Plaza Holdings, LLC, regarding rent, utilities, parking and other lease 15 ~ssues. The Receiver terminated the lease effective May 10, 2008. Finally, the Receiver made 16 arrangements with the new tenant, Ocean View Capital, and Tuco's Internet, bottled water and 17 cleaning services, to assign the contracts to Ocean View Capital, thereby avoiding cancellation 18 fees. 19 20 G. Filing the Judgment in Other Jurisdictions

Pursuant to 28 U.S.C. § 754, the Receiver caused certified copies of the Judgment to be

21 filed in the United States District Courts for the Northern District of Illinois and the Northern 22 District of Texas to assist in obtaining jurisdiction and control of Tuco property located in those 23 districts. The filings were completed within 10 days of entry of the Judgment, pursuant to 24 section 754. The Receiver will file the Judglnent in such other jurisdictions as he deems 25 appropriate based on his continuing investigation. 26 27 H. Tuco Website

Prior to the Receiver's appointment, Tuco maintained a website at www.tucotrading.com.

28 On March 12, 2008, the Receiver created a webpage for this case at his website, www.tflinc.com.
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1 After entry of the Judgment, the Receiver caused the Tuco website to be shut down and redirected 2 all traffic to his website. The webpage for this case at the Receiver's website includes the TRO, 3 Supplement, Judgment, Order in Aid, Notice of Appeal and notices to investors, all of which can 4 be viewed and printed. This report, including the Preliminary Accounting and other Exhibits, will 5 also be posted. The Receiver will continue to update the SECv. Tuco Trading page on his 6 website with all pertinent Receiver's Reports, Court filings and Orders. 7 8 I. Communications with Members and Creditors

The Receiver has sent two e-mail notices to Tuco's Members advising them (a) of the

9 status of the case and the Receiver's investigation, (b) that the Receiver obtained an extension to 10 file the 2007 Tuco federal tax returns until October 15, 2008, and that Member K-1 statements 11 would be issued in colmection with that filing, and (c) regarding the possibility of the Receiver 12 proposing an interim distribution. These notices, which were sent to all kmown Member email 13 addresses on March 20 and March 28 respectively, are attached hereto as Exhibits C and D. The 14 March 20 notice instructed all Members to provide the Receiver with updated contact information 15 if their contact infon~aation should change. The Receiver's staff has maintained and updated a 16 Member email list and creditor mailing list. The Receiver, with the assistance of his staff and 17 Allen Matkins, has also returned numerous telephone calls and emails from TuCo Members and 18 creditors. 19 20 V. INVENTORY OF ASSETS

Attached hereto as Exhibit A is Ling's Preliminary Accounting of Tuco ("Preliminary

.21 Accounting"). The Preliminary Accounting tracks the activity and financial condition of Tuco 22 from inception on November 1, 2006 through May 5, 2008. It must be emphasized, however, that 23 the analysis and conclusions drawn to date are preliminary only. As noted above, the Receiver 24 and Ling have reviewed and analyzed a great deal of information in a short period of time. During 25 its 21-month life span between August 14, 2006 and May 5, 2008, Tuco maintained five bank 26 accounts, eleven brokerage accountss and approximately 323 Member accounts. Tuco used 27 28
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8

The brokerage accounts used by Tuco are listed on Exhibit VI to the Preliminary Accounting. The account with broker-dealer Lightspeed under the name Schiller, LLC is not listed on Exhibit VI, but is included in Exhibit XXII (Sulmnary of Related Party Activity for Frank
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1 approximately eight differem Trading Platforms and six differem broker-dealers.9 Tuco received 2 or made loans, or had credit m-rangements with as many as nine different financial institutions and 3 private parties. The analysis of activity, statements, reports and specific transactions for these 4 numerous bank, brokerage, credit and Member accounts is ongoing. 5 In particular, Members should understand that the Member account balances listed in

6 Exhibits IX. A-C. to the Preliminary Accounting are based on the best information currently 7 available, and are subject to adjustment by the Receiver as the outstanding issues discussed herein 8 (and any new issues that arise) are resolved. The Receiver and Ling intend to file an updated 9 accounting with the Court in connection with the Receiver's Second Interim Report. 10 .11 A. Investigation of Assets

The Receiver's investigation into the following items listed on the Tuco Financial

12 Statement prepared by Frederick and filed with the Court on March 11, 2008 ("Tuco Financial 13 Statement") and/or stated to be assets of Tuco bY Frederick is ongoing: 14 15 1. GLB Trading Receivable

The Tuco Financial Statement lists an amount of $2,554,028 fdr "Commissions Owed"

16 from GLB as of February 28, 2008. Since that time, GLB has made COl-nmission pa3nnents to 17 FredericldTuco totaling $1,693,005.88. GLB has produced Coimrdssion reconciliation statements 18 for months through and including March 2008. The Receiver and Ling are in the process of 19 reviewing and reconciling the monthly statements produced by GLB, including amounts deducted 20 by GLB from gross Comrnissions both before and after entry of the Judgnnent freezing Tuco's 21 assets and prohibiting creditors from using self-help. Specifically, GLB made "net" Commission 22 payments to the Receiver for Commissions earned by Frederick in February and March, after 23 offsetting various fees and charges, including legal fees. These l~et pa3aaaents were made after 24 entry of the Judgment, on March 26, April 1, April 9 and May 27, 2008. Sulrnnaries of the 25 26 27 28
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McDonald). Tuco's use of the Schiller, LLC account is discussed further below. The bank accounts, brokerage accounts and Member accounts are listed throughout the Exhibits to the Preliminary Accounting. Also listed and included in the Receiver and Ling's ongoing review are two Evolution bank accounts and five Evolution brokerage accounts.
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1 Comrnissions paid to Frederick by GLB and the deductions made by GLB are attached to the 2 Preliminary Accounting as Exhibits VII and XX respectively. 3 Additionally, Tuco issued an interest-free loan of $250,000 to GLB and/or its President,

4 Robert Leclunan, on November 15, 2007. According to Frederick, the loan was for GLB to set up 5 "Portfolio Margin" trading, a° which supposedly would allow Tuco greater leverage for its 6 brokerage accounts with GLB. Portfolio Margin trading was never set up, however. GLB has 7 made payments on the loan totaling $150,000. A balance of $100,000 remains. 8 9 2. NYFIX Charges

The Tuco Financial Statement lists an amount of $819,990 for "ECN Fees Owed" from

10 NYFIX. The Receiver interviewed Frederick, Gus Katsafaros of GLB, and Brian Carr and Paul 11 Fitzpatrick of NYFIX regarding tl~s issue. The Receiver understands that, pursuant to certain 12 securities regulations (referred to as "Reg. NMS"), there are fees assessed by NYFIX for trade 13 orders that must be satisfied by directed, specific brokerage houses or firms, rather than the entire 14 market place. NYFIX assessed these charges to GLB for trades orders placed by Tuco. GLB 15 deducted these charges from Commissions payable to Frederick. Tuco and Frederick would then 16 allocate the charges to the~ appropriate Members of Tuco and make the corresponding adjustments 17 to their Member account balances. 18 Tuco and Frederick were unable to allocate $819,990 of these charges to its Members.

19 According to Frederick, NYFIX did not provide sufficient infonuation when it reported the 20 charges to GLB. Frederick has stated that he was told by representatives of NYFIX that the 21 charges would be waived if Tuco was unable to allocate them to its Members. According to 22 NYFIX, it has provided all of the infonuation that it has regarding the charges and the trades to 23 which they relate. NYFIX has stated that it will not waive the charges. 24 With the assistance of IT, the Receiver has undertaken to allocate the charges to the

25 applicable Members. This work is ongoing. 26 27 28
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10

Portfolio Margin trading is understood generally by the Receiver to be an alternate method of calculating margin limits on trading accounts. Depending on the account, Portfolio Margin may allow the trader greater leverage. Accounts eligible for Portfolio Margin trading must meet specific requirements under SEC regulations.
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1 2

3.

Penson Interest Charges

The Tuco Financial Statement lists an amount of $170,147.17 for "Interest Owed" from

3 Penson as of January 31, 2008. The Receiver has interviewed Frederick and Gus Katsafaros of 4 GLB, and obtained documents through counsel for GLB and Penson regarding this issue. The 5 Receiver understands that Penson deducts interest charges from Tuco accounts at Penson when 6 Penson loans money in order for Tuco to meet overnight margin limits. These interest charges 7 have been cancelled and credited to Tuco upon review and recognition by Penson that the margin 8 limits were in fact met on the relevant date. Information that the Receiver has received to date 9 indicates that the amount listed on the Tuco Financial Statement is not accurate. The documents 10 produced GLB indicate thatthe alnount listed is too low, while the documents produced by 11 Penson indicate that the amount is too high. The Receiver has requested additional information 12 from Penson regarding these charges. 13 14 4. T3 Ownership Interest

In his testimony before the SEC and in interviews with the Receiver, Frederick has stated

15 that Tuco holds a 10% ownership interest in Tuco Member T3. T3 is a limited liability company 16 headquartered in New York. The Receiver has discussed this matter with T3 and requested 17 documentation from its counsel relating to this interest. The documents requested have not yet 18 been received. The Receiver does not yet know what value, if any, this ownership interest may 19 have. 20 21
B. Investigation of Payments

Additionally, the Receiver is investigating various payments to and from Tuco, and

22 amounts deducted froln Commissions earned by Frederick. The Receiver's ongoing investigation 23 includes, without limitation, the following payments and deductions: 24 25
1. GLB Deductions

GLB deducted various amounts from the gross Commissions earned by Frederick. The

26 Receiver has discussed these deductions with Frederick and requested information about certain of 27 theln from GLB. These deductions include: 28
LAW OFFICES Allen Matklns Leck Gamble Mallory & Natsls LLP

1) Industry fees and charges for Tuco's trading activity;

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1 2 3 4

2) GLB's monthly service fees of $15,000; 3) Rent and other charges pertaining to the Chicago office space which Tuco sub-leased
froln GLB;

4) GLB's legal fees and other costs pertaining to this case, the FINRA Proceeding

5 (discussed below), an investigation relating to certain trades of Tuco Member Jamie Hodge; and 6 an SEC investigation of GLB. 7 8 9 ¯A summary of these deductions is included in Exhibit XX to the Preliminary Accounting. 2. Schiller/Southwest Securities

Tuco made payments to and received payments from an account at Southwest Securities

10 under the name Schiller, LLC. The Receiver interviewed Frederick regarding these transactions. 11 Per Frederick, in early 2007, Tuco decided to make the Trading Platform Lightspeed available to 12 its Members. This decision was made in connection with opening a Tuco account for Member T3, 13 which preferred Lightspeed to other Trading Platforms. 14 Lightspeed, which is a broker-dealer in addition to being a Trading Platform, did not have

15 an account at Tuco's clearing broker Penson. Accordingly, Tuco needed an account with 16 Southwest Securities, the clearing broker used by Lightspeed, in order to mal(e the Lightspeed 17 platform available to its Members. McDonald already had an account at Southwest Securities 18 under the name Schiller, LLC. Tuco and McDonald agreed that Tuco would temporarily use 19 McDonald's Schiller account for the Tuco Members using the Lightspeed Trading Platform. 20 Lightspeed agreed to open an account with Penson by June 1, 2007. 21 In fact,. Lightspeed did not set up an account at Penson Until much later. Tuco began using

22 the Schiller account at the end of March 2007 and did not terminate use of the account until 23 December 2007. The Receiver has received and is currently reviewing statements from 24 Lightspeed for the Tuco activity in the Schiller account. 25 26 3. Halperin/Marquis Jet Partners

David Halperin had Member accounts at Tuco under the nmne CT Trade. Mr. Halperin

27 also received commission paylnents from Tuco for Members that he referred. These payments 28 generally went directly to Mr. Halperin, although on one occasion Tuco issued a payment on
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1 behalf of Mr. Halperin to a company called Marquis Jet Partners. A summary of these 2 transactions is attached to the Preliminary Accounting as Exhibit XXIV. 3 4 4. Jonathan Kirldand

Jonathan I~drkland was a managing member of Evolution. When Tuco acquired Evolution,

5 a loan Mr. Kirkland had previously made to Evolution was assumed by Tuco and repaid. 6 According to Frederick, Mr. Kirkland relocated to China in early 2007. Mr. F-drkland received 7 periodic payments from Tuco and was involved with Tuco Member Blackhawk Trading 8 ("Blackhawk"). The Receiver understands that Blacld~awk is a Chinese company owned by 9 Mr. Kirldand and a partner named Ferdinand Ledesma." Blackhawk is headquartered in Hong 10 Kong. Blackhawk's Member account had a negative balance of $266,080.98 as of May 5, 2008. 1i A summary of the transactions between Tuco and Mr. Kirkland is attached to the Preliminary 12 Accounting as Exhibit XIX. 13 14 5. Michael Kestler

Michael Kestler was a managing member of Evolution. He was the "head of trading" for

15 Tuco, a role that included participating in the Tuco Internet chat room, monitoring Member 16 accounts for risk purposes, and consulting with Members on various trading issues. Mr. Kestler 17 received periodic payments or other compensation from Tuco. According to Frederick, 18 Mr. Kestler is the guarantor on a $100,000 line of credit obtained by Evolution and on which Tuco 19 has made pa3a~ents. Mr. Kestler has an account at Tuco with a negative balance of $54,715 as of 20 May 5, 2008. Tuco made a $25,000 loan to Black Cat, LLC, an entity owned by Mr. Kestler, 21 which has not yet been repaid. A SUlrnnary of the transactions between Tuco and Mr. Kestler is 22 attached to the Preliminary Accounting as Exhibit XVIII. 23 24 6. Lisa H-gatt/Kayo Financial

Lisa Hyatt, owner of Kayo Financial ("Kayo"), had various transactions with Tuco. These

25 transactions are sumnnarized in Exhibit XXIII to the Preliminary Accounting. Ms. Hyatt/Kayo 26 invested in Tuco as a class A member. These funds came from an entity called E.S. Lovell, at 27 which Ms. Hyatt was employed at the time. The investment was later recharacterized as a loan 28 and the amount transferred fi'om E.S. Lovell was repaid by Tuco with interest. Tuco then loaned
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1 Kayo funds to invest in a clearing broker called ETC Clearing. The loan from Tuco was repaid by 2 Kayo with funds that came from E.S. Lovell. 3 Ms. Hyatt/Kayo used desk space at the Tuco Premises. The Receiver understands that

4 Ms. Hyatt, in partnership with Michael Kestler, owns Ocean View Capital, the entity that leased 5 the Tuco Premises from the landlord after the Receiver terminated the lease. 6 7 VI. SHORTFALL ANALYSIS The analysis performed by the Securities and Exchange Commission ("SEC") and

8 presented in connection with its Complaint and Ex Parte Motion for TRO indicates that a shortfall 9 existed with respect to Tuco's assets and the aggregate Member account balance. The shortfall 10 reported by the SEC was $3.51 million as of December 31, 2007, and $1.35 million as of 11 January 31, 2008. 12 The Receiver and Ling have endeavored to determine whether, and in what amount, a

13 shortfall existed with respect to Tuco's net assets over liabilities and aggregate positive Member 14 accomit balance. This preliminary assessment, shown on Exhibit XVI to the Preliminary 15 Accounting, indicates that a shortfall existed in the following amount on the following dates: 16 17 18 19 20 December 31, 2006 December 31, 2007 March 5, 2008 May 5, 2008 $1,507,881 $1,553,396 $2,990,805 $3,026,373

As noted above, this analysis is preliminary only and is subject to adjustment as the

21 Receiver's investigation continues and outstanding issues are resolved. 22 23 VII. RECEIPTS AND DISBURSEMENTS Attached hereto as Exhibit B are schedules prepared by the Receiver reflecting receipts and

24 disbursements for the Tuco receivership account from March 18, 2008 through May 15, 2008. As 25 of that date, the balance in the Tuco receivership account was $9,779,314. The receivership 26 account balance has grown steadily as balances from Tuco bank and brokerage accounts have been 27 received, Commissions have been paid, and interest has been earned. The Receiver has obtained a 28 rate of interest higher than the money-market rate currently available at most banks due to the
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1 substantial balance in the receivership account and the volume of business he has with California 2 Bank & Trust. The account is currently earning interest at the rate of 2.7%. This rate is also 3 higher than that currently available for most short-term certificates of deposit. 4 5 VIII. CREDITORS AND CLAIM AMOL~TS The Receiver sent a letter to all lmown creditors advising them of his appointment and that

6 they should communicate directly with him on all Tuco-related matters. He also had all telephone 7 calls and mail sent to the Tuco offices forwarded to his office. The largest creditor claim appears 8 to be held by Lightspeed. Lightspeed has sent the Receiver invoices stating that it is owed more 9 than $1.3 million. Tuco's books and records indicate that remaining creditor claims combined 10 total less than $200,000. 11 As reflected in the Preliminary Accounting, the aggregate Member account balance as of

12 May 5, 2008 was approxhnately$12,3 million. The largest Member claims are held by Lanai and 13 T3. 14 15 IX. PENDING AND POTENTIAL LITIGATION The Receiver is not aware of any pending litigation, other than the instant proceeding, in

16 which Tuco has been named as a party. The Receiver is informed that the SEC has commenced an 17 administrative proceeding against Frederick. 18 GLB Trading was nmned in a proceeding initiated by The Nasdaq Stock Market

19 ("Nasdaq") before the Financial Industry Regulatory Authority Office of Hearing Officers in or 20 about November 2007 ("FINRA Proceeding"). This proceeding was the result of an investigation 21 into certain trade orders that violated the New York Stock Exchange's rules and policies regarding 22 the use of partial or odd-lots. GLB identified these trade orders as coming from Tuco, which in 23 turn identified them as coming from Member Lanai. The trade orders were made by Lanai using the Trading Platform of Sterling Financial Services ("Sterling"). 25 In December 2007, GLB and Nasdaq agreed to settle and dismiss the FINRA Proceeding

26 on certain terms and conditions, including (a) that GLB permm~ently terminate all customers 27 ka~own to have engaged in the trades at issue, (b) that GLB retain, at its own expense, an 28 independent consultant to evaluate, examine and audit GLB and its preventative system processes,
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1 whether at GLB or at Sterling, (c) that the independent consultant again conduct a review at GLB's 2 expense 120 days after his initial review, and (d) that GLB fully cooperate with the independent 3 consultant (the "Settlement"). The independem consultant selected by Nasdaq and GLB 4 conducted his initial review in February 2008. The follow-up review is scheduled in June 2008. 5 As a result of the FINRA Proceeding and the Settlement, GLB has deducted certain legal

6 fees and costs fr