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United States Commodity Futures Trading Commission v. Lake Shore Asset Management Limited

October 4, 2007

UNITED STATES COMMODITY FUTURES TRADING COMMISSION, PLAINTIFF,
v.
LAKE SHORE ASSET MANAGEMENT LIMITED, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Blanche M. Manning United States District Judge

MEMORANDUM AND ORDER

The CFTC's motion for appointment of a receiver, its submission regarding documents relating to the Lake Shore Funds' separately managed account ("SMA") documents, Lake Shore Limited's submission regarding these documents, which the court construes as a motion for a protective order, and Lake Shore Limited's "notice of related action" are before the court. This order will also address the effect of the Canadian receivership on this action.

Lake Shore Limited's request for a protective order directed at the SMA documents is denied, and the CFTC's motion for appointment of a receiver is granted. Moreover, as discussed below, there is a fine line between, on the one hand, a party's pursuit of a particular position and vigorous advocacy from that party's lawyer and, on the other hand, obstructionism. Lake Shore Limited and its lead counsel, William Nissen, may well find that they have landed far on the wrong side of this line. Thus, for the following reasons, a rule to show cause why it should not be held in civil contempt and sanctioned pursuant to Fed. R. Civ. P. Rule 37(b)(2) and the court's inherent powers is issued against Lake Shore Limited, and a rule to show cause why he should not be sanctioned under Fed. R. Civ. P. 37(b)(2), 28 U.S.C. § 1927, and the court's inherent powers is issued against Mr. Nissen.

I. Background

A. Recent Events

The court assumes familiarity with its August 28, 2007, order addressing the CFTC's motion for a preliminary injunction and thus will summarize developments post-dating that order. See CFTC v. Lake Shore Limited, No. 07 C 3598, docket # 118 ("Injunction Order"). First, despite the fact that the Injunction Order required immediate production of or access to certain CTA/CPO documents and the Seventh Circuit denied Lake Shore Limited's request for a stay pending appeal, Lake Shore Limited has produced no documents and refused to allow the CFTC to inspect any of its records. Instead, it raises a new argument: that foreign secrecy laws prevent it from producing SMA and fund documents.*fn1

Second, the reader may recall the dead-of-night "office move" of Lake Shore's London office (more specifically, the Lake Shore Group of Companies Inc. Limited's office) at the direction of Philip Baker, the Managing Director, Principal and President of Lake Shore Limited and the co-founder and managing partner of the Lake Shore Group of Companies, as well as a principal in numerous other Lake Shore entities.*fn2 The CFTC represents that Lake Shore has recently vacated its Hong Kong office and that Mr. Baker has been sending letters to certain of its agents, employees and sales representatives stating:

We ask that you return any and all Lake Shore property that is in your possession, including name cards, cell phones/pdas, computers and peripheral devices, VOIP phones and all files whether hard copy or electronic relating to the business of Lake Shore. Your '@lakeshorefunds.com' email account shall be deactivated, and you will lose access to the Lake Shore 'Microsoft Exchange Server.'

In response, Lake Shore Limited denies that Mr. Baker is trying to collect and hide records, and characterizes the letters as part of the normal course of business and caused by the termination of the employer-employee relationship between Lake Shore and the recipients of the letters. Mr. Nissen also has assured the CFTC that the records are more likely to be preserved if they are collected by the Lake Shore Group, as opposed to being left with the former employees. The court is, to say the least, skeptical of this unsupported position given Lake Shore Limited's refusal to turn over its own 2007 CTA/CPO records as ordered by the court, let alone its refusal to turn over other CTA/CPO records for other members of the Lake Shore common enterprise.

The third recent development of note is that Mr. Baker has caused an action to be filed in the High Court of Justice, Queen's Bench Division, Commercial Court in England. In this action, Lake Shore Alternative Financial Asset Limited, Lake Shore Alternative Financial Asset Limited Account I Limited, Lake Shore Alternative Financial Asset Limited Account II Limited, Geneva Corp. Funds World Limited (formerly known as Lake Shore Alternative Financial Asset Fund IV Limited), and Hanford Investments Limited sought relief as to the money held at the three London FCMs (Lehman, Fimat, and Man).*fn3 Specifically, they ask for an order transferring the money there to them and: an injunction restraining each of the Defendants from complying with any request or demand by the United States Commodities and Futures Trading Commission or the United States National Futures Association or any branch or agent thereof or any receiver appointed at the suit thereof, to transfer the sums and assets standing to the credit of the Claimants with the relevant Defendants as referred to above out of the jurisdiction of this Court or to deal with them in any way contrary to the instructions of the relevant Claimant, save to the extent that the appointment of such receiver and/or the validity of his request or demand in respect of such sums or assets has been recognised and enforced by this Court.

Fourth, on September 24, 2007, in In re Sentinel Management Group, No. 07-14987 (Bankr. N.D. Ill.), attorneys from Vedder, Price, Kaufman & Kammholtz filed appearances on behalf of "Ernst & Young, Inc., as Receiver for Lake Shore Alternative Financial Asset Corporation Limited and Lake Shore Alternative Financial Asset Corporation 2006 Limited."*fn4

The court takes judicial notice of this filing and the September 13, 2007, order from the Ontario Superior Court of Justice, No. 07-CL-7168, appointing Ernst & Young as a receiver.

The September 13, 2007, order appoints Ernst & Young as a receiver of all Lake Shore Alternative Financial Asset Corporation Limited and Lake Shore Alternative Financial Asset Corporation 2006 Limited's "current and future assets, undertakings and properties of every nature and kind whatsoever, and wherever situate including all proceeds thereof." Id. at ¶ 2. Evidence presented at the preliminary injunction hearing showed that familiar names are associated with Lake Shore Alternative Financial Asset Ltd.: Mr. Baker is the President and Secretary and John Kurgan is the Chief Executive Officer. With respect to Lake Shore Alternative Financial Asset Corporation 2006 Limited, Lawrence Rosenberg is the Chairman of its Board of Directors, Mr. Baker is its President, and John Kurgan is its Secretary.

Rod Macdonald, the Director and Chief Financial Officer of KRG Children's Charities (the applicant in the Canadian case), submitted an affidavit to the Canadian court stating that Lake Shore Asset Management Inc. was the portfolio manager of the hedge funds at issue in the Canadian case. The reader may recall that Lake Shore Inc. is the firm name for Lake Shore Alternative Investment, which is 100% owned by Senior Management of Lake Shore Asset Management. In addition, Lake Shore Limited's legal name is "Lake Shore Group of Companies Inc., Ltd." and Lake Shore Limited is the reorganized version of Lake Shore Inc.

B. Hearing Relating to the Impact of the Canadian Case

This court held a hearing on September 28, 2007, to address the impact of the Canadian case on this case and asked the Canadian receiver's counsel to appear. Counsel did so and indicated that if this court treated all of the Lake Shore entities as a single entity, there could be a conflict between it and any receiver appointed by this court, but that any such conflict could be addressed, possibly by referring to protocols established between Canadian and U.S. courts dealing with cross-border insolvencies. The court reserves this issue for another day, as it has not made any findings as to the total number of Lake Shore entities that are part of the common enterprise. Indeed, it could not at this time, given the lack of complete Lake Shore records and the fact that additional Lake Shore enterprises requiring complex diagramming seem to be constantly popping up.*fn5

The receiver also clarified that the Canadian court was not presently attempting to control all of Lake Shore's assets, but instead was exercising jurisdiction over Lake Shore Alternative Financial Asset Corporation Limited and Lake Shore Alternative Financial Asset Corporation 2006 Limited.

The parties disagree as to the relationship between Lake Shore Alternative Financial Asset Corporation Limited and Lake Shore Alternative Financial Asset Corporation 2006 Limited and the Lake Shore Funds. According to Lake Shore Limited, these entities are customers of the Lake Shore Funds. As depicted in the chart attached to the Injunction Order, this clarification is not particularly helpful as Lake Shore Funds I, II, III, and IV flow downward into numerous places. Mr. Brodersen, however, testified during the preliminary injunction hearing that their status as bona fide customers was unclear. (Brodersen Tr. at 177:25-178:8).

During the September 28, 2007, hearing, there was also some discussion as to whether Lake Shore Alternative Financial Asset Corporation Limited and Lake Shore Alternative Financial Asset Corporation 2006 Limited could be a pool within a pool. In addition, the CFTC suggested that Mr. Baker had created a maze of interrelated companies and in this instance, one entity may have loaned money to another and sold an investment vehicle as part of that transaction. These questions are all open and cannot be resolved based on the present record.

With respect to timing for distribution of monies if a receiver is appointed, the CFTC represented that an interim distribution could occur within a relatively short period of time. The court also heard an offer of proof from an attorney representing a South American investor, who stated that her client would testify that Mr. Baker contacted him and indicated that if he cooperated with the CFTC and a receiver was appointed, it could take five to seven years to receive any money. This conversation "was in the context of trying to get the customer to kind of weigh in and work with Mr. Baker rather than cooperating with the CFTC." The customer contacted counsel because this "didn't sound right to him." (9/28/07 Tr. at 19:22-21:3). Lake Shore Limited then characterized this conversation as nothing more than a factual representation that a receivership could delay distribution of funds.

C. Affidavit of Antonio Recabarren

Finally, in further support of its motion to appoint a receiver, the CFTC submitted an affidavit dated September 27, 2007, from Antonio Recabarren, a partner in Recabarren y Asociados in Santiago, Chile. In November of 2006, Mr. Recabarren met with Mr. Baker and others, they discussed Lake Shore's trading programs, and Mr. Baker gave Mr. Recabarren documents relating to Lake Shore Funds I, II, III, and IV. These documents stated that the investment manager for each fund was Lake Shore Limited, an entity located in Chicago and a member of the NFA. The marketing materials represented that the annualized returns for each fund ranged from a low of 10.9% (Lake Shore II) to a high of 37.2% (Lake Shore IV). Based on these representations, Recabarren y Asociados entered into a distribution referral agreement with Lake Shore Group, and Mr. Baker signed the agreement as the Managing Director of that Lake Shore entity. Under that agreement, Recabarren y Asociados referred more than 20 Chilean investors who invested approximately $14M.

Mr. Recabarren recently learned about this case, the Injunction Order, and the case filed in England seeking release of money held at the British FCMs to members of the Lake Shore common enterprise and Hanford Investment. He stated that he believed that it was in the best interests of the investors he referred to Lake Shore for a receiver to be appointed in this case as soon as possible, and for the receiver to handle the distribution of assets to investors. He also opined that it would not be in the investors' best interests for any Lake Shore assets to be released to Lake Shore Group, any of its affiliates, or Mr. Baker or any entity controlled by him.*fn6

II. Discussion

A. Failure to Produce Documents from Lake Shore Limited/Lake Shore, Inc./Lake Shore Group of Companies Relating to Their Activities as a CTA and CPO for the Lake Shore Alternative Financial Asset Funds

The Injunction Order required Lake Shore Limited, Lake Shore, Inc. (which Lake Shore Limited is a mere continuation of), and the Lake Shore Group of Companies (which consists of Lake Shore Limited) to immediately produce documents relating to any activities as the CTA and CPO for the Lake Shore Alternative Financial Asset Funds. On September 7, 2007, the Seventh Circuit denied Lake Shore Limited's motion for a stay of the Injunction Order pending disposition of Lake Shore Limited's appeal. Lake Shore Limited then waited until September 19, 2007, to respond in any way to the court's order to produce documents or allow inspection. It only appears to have done so because on September 11, 2007, the court advised Lake Shore Limited that to the extent that it believed that any legal theory entitles it to withhold information, it bore the burden of affirmatively bringing any such theory to the court's attention, as opposed to waiting for the CFTC to file a motion to compel.

In Lake Shore Limited's September 19th memorandum, it contends that the Injunction Order is improper because it requires Lake Shore Limited to produce records of foreign funds and thereby violate foreign privacy and secrecy laws. Lake Shore Limited takes issue with the fact that the court did not previously address this foreign law argument. Given that Lake Shore Limited provided a detailed discussion of its foreign secrecy law argument to this court for the first time after the Injunction Order issued, Lake Shore's contention that the court is to blame for Lake Shore Limited's decision to withhold this argument until now is frivolous. Indeed, it would have been more efficient to address all of the document issues at the same time. The court will discuss the merits of this argument below, but briefly notes for present purposes that it only relates to the SMA documents, and the court expressly declined to address production of these documents in connection with the CFTC's motion for a preliminary injunction without further briefing from the parties.

It is also important to note that for purposes of the CTA/CPO documents for the Lake Shore Alternative Financial Asset Funds, foreign secrecy laws are irrelevant because -- as the court has said time and time again -- requiring Lake Shore Limited to produce its own documents in its role as the CTA and CPO for the Lake Shore Alternative Financial Asset Funds is not the same thing as requiring it to produce fund documents. See Injunction Order at p. 56 ("Lake Shore Limited must allow inspection of its books and records relating to the Lake Shore Alternative Financial Asset Funds in their entirety as of the date of its CFTC registration. In the interests of staving off future disputes, the court clarifies this statement by noting that this means all of its books and records kept in connection with its activities as a CTA and CPO for the Lake Shore Alternative Financial Asset Funds, not just the records relating to Fund IV -- U.S. and the single U.S. investor"); CFTC v. Lake Shore Limited, docket nos. 126 and 153. Indeed, the court specifically stated "[a]t the risk of being repetitive, the court reiterates that the fact that the Lake Shore Alternative Financial Asset Funds themselves and the vast majority of the investors are outside the U.S. is irrelevant. Lake Shore Limited's record keeping obligations flow from its activities as a CTA and CPO under the Act. The court is not ordering the funds themselves or the investors to do anything. Instead, its order is exclusively directed at Lake Shore Limited." Injunction Order at 58. The court's order could not have been any clearer, yet Lake Shore Limited has not complied and has instead continued to characterize the court's order as requiring it to produce fund and/or SMA documents.

The same goes for Lake Shore, Inc. and the Lake Shore Group of Companies. The court found that Lake Shore Limited was a mere continuation of Lake Shore Inc., which was registered CTA and CPO until its registrations were withdrawn in February of 2007, and Lake Shore Inc. was part of the Lake Shore Group and currently consists of Lake Shore Limited. It then stated that "[t]his means that Lake Shore Limited is not expected to possess records prior to January 17, 2007, in its capacity as Lake Shore Limited. In contrast, it would be expected to possess records in its previous incarnation as Lake Shore Inc., as part of the Lake Shore Group common enterprise, and as the acting CTA and CPO for the Lake Shore funds. It thus must allow inspection of any CTA and CPO records predating January 17, 2007" to the extent that those records related to any Lake Shore entity's position as the CTA or CPO for the Lake Shore Alternative Financial Asset Funds. Id. at 61. Again, the court's order is crystal clear, yet no documents have been produced other than the Fund IV -- U.S. and U.S. investor documents, which the court held was insufficient.

This is not a situation where nothing has been produced because there is nothing to produce: Mr. Rosenberg allowed access to Lake Shore Limited's records for a very short time before this access was revoked, and the CFTC/NFA were unable to review all of the records that were responsive to the document requests and this court's order during the brief window that Lake Shore Limited provided. Moreover, the current document impasse makes it impossible to order any sort of interim distribution of the known monies, given that the court needs to know, at the very least, who the investors are and how much they invested for this to occur. See CFTC v. Lake Shore, No. 07-3070 (7th Cir. Sept. 7, 2007) (unpublished order) (noting the Seventh Circuit's assumption that this court would be receptive to applications filed by any of Lake Shore Asset Management's customers who want their funds released while litigation continues).

If Lake Shore Limited believed that any legal justification existed which supported its decision to not produce any documents or allow inspection, it bore the burden of affirmatively and promptly bringing any such justification to the court's attention. Yet, despite the court's use of the word "immediate" in the Injunction Order and the Seventh Circuit's September 7th denial of Lake Shore Limited's motion for a stay of that order pending appeal, the status of document production remains at a standstill.

So, after this long wait, what does Lake Shore Limited have to say about its failure to comply with the Injunction Order?

* Accounts of the Lake Shore Funds, with the exception of the account maintained at Lehman for which Lake Shore Limited had a power of attorney for trading, were not owned or traded by Lake Shore Limited.

- The court previously found that the CFTC had a strong likelihood of success on its claim that Lake Shore Limited acted as the CTA and CPO for the Lake Shore Alternative Financial Asset funds. It also explicitly rejected the argument that because Lake Shore Limited does not hold fund accounts in its name or have the ability to withdraw money in its capacity as Lake Shore Limited, it can disclaim responsibility for records relating to these accounts. As the court noted, it legally cannot do these things because clients invest in a specific fund pursuant to that fund's offering documents, and these monies are deposited with a FCM in accounts which are owned by that fund and are in that fund's name. See Injunction Order at 71. The court subsequently characterized Lake Shore Limited's repetition of this argument as bordering on the frivolous. CFTC v. Lake Shore Limited, docket # 126 at 4. Yet, Lake Shore Limited trots this argument out again today without acknowledging or attempting to address the court's prior rulings. Setting this aside, the court has repeatedly distinguished between Lake Shore Limited's obligation to turn over its own CTA/CPO records and an obligation to produce fund records. The time to produce fund records may arrive sooner than Lake Shore Limited would like, but in the meantime, Lake Shore Limited must comply with the court's Injunction Order by producing its CTA/CPO records. Similarly, as discussed in the Injunction Order, Lake Shore Group and Lake Shore Inc. must also produce any CTA/CPO records.

* The court lacks jurisdiction over the foreign activities of the Lake Shore Funds because the Commodity Exchange Act does not have extraterritorial effect.

- The Injunction Order addressed the reach of the Commodity Exchange Act and found that Lake Shore Limited had to immediately produce certain documents. Lake Shore Limited appealed, and the Seventh Circuit denied its motion for a stay pending appeal. One would think that this would be the end of the matter and Lake Shore Limited would comply with the court's order. Regrettably, however, Lake Shore Limited's counsel has inexplicably adopted the position that it is acceptable to repeat a rejected argument and ignore the court's clear directive to his client.

* The court's finding that Lake Shore Limited is a mere continuation of Lake Shore Asset Management, Inc. and is in a common enterprise with the Lake Shore Group of Companies does not establish that Lake Shore Limited has physical possession, ...


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