Doug Donnell at the Mika Meyers Beckett and Jones office
LEGAL NEWS PHOTOS BY CYNTHIA PRICE
by Cynthia Price
Legal News
People who have difficulty thinking in devious ways will find the story of Cyberco, Teleservices and the late Barton Watson convoluted and hard to follow.
But while attorney Douglas A. Donnell of Mika Meyers Beckett and Jones experiences at times the same moral outrage as a stranger to the story, he is so familiar with what happened that he can tell it fairly simply.
To do so, he draws a diagram on a white board at Mika Meyers. The main players, in addition to Cyberco and Teleservices, are the investors in Teleservices, and Huntington Bank.
It is the bank which Bankruptcy Court Judge Jeffery Hughes has recommended should pay an $81 million settlement to Teleservices’ creditors, as a result of the work of Doug Donnell and his team.
Serving on that team were Mark A. Kehoe, also of Mika Meyers Beckett & Jones (with some assistance from Amy VanDyke of MMBJ); John E. Anding of Drew, Cooper & Anding, who represented some of the creditors; Marcia R. Meoli, Hann Persinger in Holland, who is also the trustee; and Peter A. Teholiz, The Hubbard Law Firm, Lansing.
“It was a fascinating case to investigate,” Donnell says. “We were able to see lots of internal correspondence. At times, Mark Kehoe and I would do nothing else for days, going over documents separately and then comparing notes and thoughts.”
The facts of the case are dramatic and fascinating.
Barton Watson owned Cyberco, a Grand Rapids technology business that started out, under another name and with a partner who later moved on, as at least partially legitimate. Cyberco, sometimes called CyberNet, was an Information Technology “solution provider,” a VAR or value-added reseller that handled comprehensive project needs of a variety of clients, some legitimate, some not.
Cyberco received a $17 million line of credit loan from Huntington Bank in the early 2000s, based primarily on its accounts receivable.
Unfortunately, those accounts receivable were non-existent. Watson and his crew fraudulently created the appearance of a rapidly growing firm.
Cyberco personnel were also behind a separate company, Teleservices, which too was non-existent. Teleservices purported to be a computer hardware firm, organized in Delaware, with a bank account in Santa Clara, California, and an address in Manhattan — in addition to a second address at 25 South Division, Grand Rapids, Cyberco’s address.
“Here’s where the fraud comes in,” says Donnell. Watson or his managers would contact an equipment financing company and ask for a loan. Cyberco officials would say that they wanted to purchase or lease computer equipment, such as servers, from Teleservices, because they could attest that Teleservices was a reputable supplier.
The finance company would send the money to Teleservices, and that company would in turn cycle the money back to Cyberco.
When financing companies asked Cyberco if they had received the goods, Cyberco said yes. If someone at the lender wanted to see the received products, Cyberco employees would slap fake serial numbers on servers they already had.
The company went so far as to add a number of empty boxes to the real servers in the basement of the South Division office, creating the image of servers inside the boxes through the use of blinking lights.
Says Donnell, “There were some things we read where you couldn’t help but laugh. They called these things ‘blinky boxes’ – and there was an email from some employee to [company president] Jim Horton, in re: Blinky Boxes, that said, ‘We’re out of Christmas lights.’”
As Cyberco financers began to wise up — and as the company bled employees who Watson threatened to sue if they told what they knew — the FBI investigated, culminating in the raid and Watson’s death at the end of 2004.
Watson, who ended his own life shortly after the raid that shut down his company, escaped punishment from the courts. But most of the top-level managers at Cyberco, including his wife Krista Kotlarz-Watson, went to prison.
Cyberco and then Teleservices filed for bankruptcy in Dec. 2004 and Jan. 2005 respectively.
The story at issue in the current case does not end there, however.
Teleservices Group, Inc./Marcia Meoli v. The Huntington National Bank concerns whether Cyberco’s bank knew or should have known about the fraud in time to stop the worst of it.
According to Huntington Bank employees’ own testimony, the bank first began to suspect something was amiss in the fall of 2003. After a bounced check in the two million
dollar range, Huntington statisticians alerted managers, who began to investigate.
Officers sat down with Kotlarz-Watson and asked her a number of questions without getting believable answers. At one point, Watson and others explained that Teleservices — which in the meantime employed a manager who allegedly answered the phone using a false name at times — was “not yet operational.”
Says Donnell, “There’s a whole series of red flags, signs of fraud, ranging from deposits in large round numbers from Teleservices to Cyberco to the nature of Teleservices as a company, and they just couldn’t get straight answers. We came up with roughly twenty of these red flags, things that just didn’t make sense.”
Huntington even asked Cyberco to find another bank in early 2004, but that did not happen. Huntington turned the investigation over to its head of security in West Michigan, who has since retired.
The security manager discovered something very telling: Barton Watson had already served time in prison for bank fraud, before he even returned to Grand Rapids and started the company that eventually became Cyberco. He had been a broker at E.F. Hutton, but his broker license had been revoked.
At that point, in April 2004, about six months had passed since the original suspicions, but the security officer chose to tell no one.
And between Sept. 2003 and the final raid, Cyberco’s fraudulent transactions had escalated.
Huntington did take, or Cyberco turned over, about $7 million to pay back the original $17 million loan, but Watson and friends had to keep bringing in more and more cash to continue repaying other loans, paying expenses, and, as is surmised, maintaining themselves in the style to which they had become accustomed.
Based on what the legal team claimed was Huntington “willfully turning a blind eye,” the trustee of Teleservices asked for a determination that not only the loan, but also the transaction amounts between Sept. 2003 and Nov. 2004, for a final amount of about $72 million, should be recovered from Huntington Bank.
After a high volume of motions and decisions, Judge Hughes agreed. With significant interest, the total is now up to $81 million.
But that is still not the end of the story.
Enter Stern v. Marshall, the United States Supreme Court decision of June 2011, which concerned the status of bankruptcy judges. Stern held that judicial power is limited to Article III judges. Since judges in the bankruptcy courts are appointed by the Federal circuit courts for a specified term (14 years), they do not fall under Article III, which requires appointment “for life” by the United States President, and confirmation by the U.S. Senate.
The Stern opinion, which decided one of the Anna Nicole Smith cases, may be interpreted as questioning whether final orders by bankruptcy judges deprive parties of constitutional due process rights, but Stern contains a lot of ambiguity.
In fact, Judge Hughes used the Teleservices decision to engage in a lengthy exploration of just what he thinks Stern means.
Donnell says, “Judge Hughes, as I think is always his practice, undertook a very scholarly process to determine what’s right in this case.”
Based on such reasoning, Judge Hughes decided that Stern requires him to submit any third party judgment recommendations to an Article III judge in the U.S. Court for the Western District of Michigan for final judgment, which will include Meoli v. Teleservices.
Donnell thinks this submission will result in affirmation of the report and recommendation, in large part because Judge Hughes has been so thorough in considering his opinions. “He is truly a student of the Bankruptcy Code,” Donnell observes.
But the final outcome of this phase of the case remains to be seen. Comments Jeffrey Birkhold of Warner Norcross and Judd, one of Huntington Bank’s attorneys, “Huntington has and will continue to vigorously contest this complex case. Huntington believes it took appropriate action at all times and the bankruptcy court’s opinions have gone beyond legal precedent.”
Donnell, who specializes in criminal litigation and environmental law, including water rights, says he has found the case all-consuming at times. Even during the worst extremes of laser focus, he made sure his other clients were served, but he admits, “It’s been an arduous case.”
But if the decision stands, he adds, “I’m pleased principally for the creditors, who are deserving of compensation.”
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