A cautionary tale about litigation funding
14th Jun 2016
By: Mary H. Terzino.
Last month in the United States, the Securities and Exchange Commission (SEC) sued Prometheus LLC, a litigation funding firm, and its owners. The lawsuit recites a multitude of sins committed by Prometheus to defraud its investors. It also claims that the litigation investments sold by Prometheus were “securities”, and that Prometheus broke the law by never registering the offer of sale of the litigation investments and unlawfully acted as a broker-dealer. The SEC seeks an injunction, disgorgement of ill-gotten gains, and civil penalties.
While many of these allegations are unique to Prometheus’ business model, they may serve as a cautionary tale for other litigation funders, especially those that pursue individual investors to fund their investments. Moreover, the circumstances also illustrate the untrammeled way in which litigation funders can operate absent specific government oversight.
The facts are complex, but essentially, the two individual owners sued by SEC are a lawyer and a non-lawyer. They formed Prometheus to conduct legal marketing, with a goal of recruiting potential pharmaceutical mass-tort claimants. In 2013 they joined forces with a law firm unconnected to their business to represent these claimants in mass tort litigation. Under the arrangement, Prometheus would get a third of any net legal fees awarded from cases handled by their partner firm. (This is a departure from the usual funder model, which grants the funder a portion of the damages recovered, rather than a portion of the legal fees.) These recoveries, in turn, would be used to pay those who invested in Prometheus. The SEC identified this scheme as improper fee splitting with non-lawyers.
All told, Prometheus raised $11.7 million from outside investors in over 1,300 transactions to fund their business. They offered guaranteed returns of between 100% – 300% depending on the amount invested and when the investment matured. Unlike some other legal funding, the maturation date for investments in Prometheus was fixed, not tied to resolution of a lawsuit.
More than 80% of Prometheus’ potential cases implicated a single pharmaceutical drug. Investors were told the enterprise was “low risk” and that settlement funds related to the drug were already waiting in escrow to be claimed. However, there was (and is) no global settlement fund for cases involving that drug, and thus no ready way to resolve the lawsuits of the claimants whom Prometheus recruited. Ultimately, lawsuits were filed for only about 700 of the approximately 2,300 potential claimants jointly represented by Prometheus, its lawyer-owner, and the outside law firm, netting the enterprise less than US$10,000 in total legal fees.
Worse, many of the investors’ contributions were apparently diverted from legal marketing and used for personal expenses and luxury goods. Further, when the first tranche of payments to investors came due, the Prometheus owners allegedly used a Ponzi-like scheme, taking money raised from new investors to pay existing investors. Prometheus will owe investors over $31 million by February 2018, when remaining investor contracts are due.
Hedge funds are investing in mass tort litigation in the US, and globally, with increasing regularity, including in the claimant-recruiting side of the arrangement. According to an April 18, 2016 story by Alison Frankel in Reuters, claimants’ lawyers in the US tell stories about being pursued by litigation funders who offer tens of millions of dollars to purchase a share of their mass tort cases.
The US litigation funder Gerchen Keller raised more than $400 million in 2015 for a new fund dedicated to investments in late-stage cases. The funder allegedly invested about $45 million in the Texas law firm AkinMears so that the law firm could acquire many thousands of pelvic mesh claims , according to a lawsuit filed by AkinMears’ former business development officer.
These stories, at least in the US, challenge funder claims that they do not control litigation, when in fact their money is coaxing claimants into the dockets of mass tort lawyers in the first instance. One lesson of the Prometheus case is that they had better do so carefully and with due regard for government imposed strictures. At least in some instances, securities laws and other laws are available to check bad behavior. But one wonders how long funders will be permitted to operate without rules that are geared expressly toward the specific nature of their business.