The trustee in DBSI’s bankruptcy case, James Zazzali, filed a lawsuit in Delaware federal court on Nov. 10 that alleges the law firm helped DBSI use new investor money to pay off old investors in a “classic Ponzi scheme.”
The firm said in a statement to the Idaho Business Review that it “emphatically denies all wrongdoing.”
The statement said the lawsuit contains “boilerplate allegations against many people” and noted that bankruptcy trustee litigation is “common – almost routine” in Delaware, where many corporations are based.
“Any allegations of wrongdoing by Moffatt Thomas are false and defamatory,” the statement said. “We will defend ourselves with vigor and integrity, for as long as it takes, until this matter is dismissed.”
In particular, Zazzali alleges Moffatt Thomas was behind the creation and structure of a key DBSI affiliate, FOR 1031 LLC, in 2003.
FOR 1031, controlled by DBSI insiders, was formed to acquire property and sell fractional shares to investors. DBSI sought to take advantage of a 2002 change in tax law that allowed investors to avoid capital gains taxes by purchasing tenant-in-common shares.
The lawsuit claims that FOR 1031 never generated a profit and was “hopelessly insolvent” as soon as 2005, but that company officials relied on new property sales to prop it up.
FOR 1031 also guaranteed monthly rent payments to investors. But another entity – DBSI Master Leaseco – was responsible for providing those payments, according to court papers.
Zazzali alleges that DBSI executives Doug Swenson and Thomas Var Reeve enjoyed all the profits from FOR 1031, even while Master Leaseco bore all expenses and losses associated with the properties.
In 2005, DBSI also began setting aside 5 percent of the money collected from investors as “accountable reserves” to pay for property upkeep and other costs.
The company collected nearly $100 million for the reserves, but only $18 million of that was used to pay for authorized expenses. The rest was channeled to other DBSI entities or used to pay investors or company insiders, the lawsuit claims.
Court papers state Moffatt Thomas was “deeply entrenched” in DBSI’s affairs, including helping with the creation of the accountable reserves and FOR 1031′s master lease structure that were “part and parcel” of the fraud.
Mark Ellison, a one-time shareholder and board member at Moffatt Thomas, also joined DBSI as general counsel in October 2004.
The lawsuit levies 16 charges against Moffatt Thomas but not specifically against Ellison. Allegations include racketeering, professional negligence, aiding and abetting breaches of fiduciary duty, aiding and abetting fraud, civil conspiracy and fraudulent transfers.
The suit seeks compensatory and punitive damages and other costs.