Audit Report 98-06, Findings and Recommendations

3. THE DEPARTMENT USED COURT-APPOINTED TRUSTEES TO MANAGE AND DISPOSE OF THE BICYCLE CLUB

Responsibility for disposal of seized assets rests with the Attorney General. Title 18 U.S.C., Section 1963(f), states: "Following the seizure of property ordered forfeited under this section, the Attorney General shall direct the disposition of the property by sale or any other commercially feasible means, making due provisions for the rights of any innocent persons." This authority for custody and sale of forfeited assets was delegated to the USMS by the Office of the Deputy Attorney General Directive No. 86-1, which states that all arrangements for property services or commitments pertaining to the property are the responsibility of the USMS.

Despite the authority vested in the Department by the statute, three trustees have been appointed by the court to oversee the government's interest in the Bicycle Club since it was seized in 1990. The first trustee, called the interim trustee, served from April 1990 through March 1993. The second trustee, called the successor trustee, served from March 1993 to April 1996. The third and current trustee, who we refer to as the replacement successor trustee, began serving in May 1996. Except for the interim trustee, it is debatable whether the Department should have utilized court-appointed trustees instead of contractors working for the USMS.

A chronology of significant events and our analysis of weaknesses in USMS oversight of each trustee follows. Also included is a discussion of each trustee's duties, compensation, length of employment, and instances where the appearance of conflicts of interest arose.

In April 1990, the court appointed as interim trustee the City of Bell Gardens' Finance Director. The court's initial involvement was necessary to protect the interests of innocent partners pending the disposition of ancillary proceedings. The court directed the general manager of the Club to continue his duties with respect to its day-to-day operations.

Documentation was generally unavailable regarding the interim trustee other than the original order of appointment. We were advised that the interim trustee's compensation was about $2,000 to $2,500 per month. Although information varies, according to USMS and AFO personnel, it appears the interim trustee spent from four to eight hours per week performing his duties at the Club. The trustee's duties were to review disbursements and co-sign and approve disbursements that previously required the signature of the General Manager. The interim trustee was paid by the Club for his first two years; subsequently, he was paid through the LCP Partnership.

Following an August 1991 settlement agreement with the LCP partners, the Department began to question the use of the interim trustee. From April 1990 until August 1991 we believe the initial trustee was necessary because the Club ownership was being determined through litigation and negotiations. When the settlement agreement was confirmed by the court, the USMS, in coordination with other Department components, was responsible for managing the asset. As a result of the settlement agreement, the USMS promptly contracted with Kenneth Leventhal & Company for a comprehensive audit and business evaluation of the Club. Leventhal informed the USMS that the Club did not have adequate financial controls and procedures in place.

In addition to concerns expressed in the Leventhal report, some Department components were concerned that the interim trustee's role as finance director for the City of Bell Gardens constituted a conflict of interest, particularly since the government now owned an identified interest in the partnership. Specifically, the U.S. Marshal for the Central District of California was concerned that given the substantial amount of tax revenue the City received from the Club, there was a perception that the trustee's main concern would be the City's revenue stream rather than the Department's interests.

Based on the management weaknesses reported in the Leventhal report and the potential conflict of interest, the Department decided to seek replacement of the interim trustee in 1992. The U.S. Marshal for the Central District of California took the position that a second court-appointed trustee was unnecessary and believed a court-appointed trustee was in direct conflict with the laws governing the USMS's management of seized and forfeited assets. Accordingly, he recommended that the Department contract with a substitute custodian under USMS direction to manage, control and protect the government's interest. The USAOs for the Southern District of Florida and the Central District of California, the AFO, the USMS Seized Asset Division and the USMS Office of General Counsel rejected this recommendation, and a successor trustee was appointed by the court.

In March 1993, the Department diluted its responsibility to manage and dispose of the government's interest in the Club by requesting the court to appoint the successor trustee instead of requiring the USMS to contract directly with a business manager. The court's order did not define the successor trustee's duties in the same detail as a contract directly between the USMS and a contractor could have. In addition, decisions regarding selection or removal of the trustee required the permission of the court. According to the USMS, it continued to use court-appointed trustees because it believed the procurement process was cumbersome and slow. We do not know how long the procurement process would have taken, but the procurement regulations provide flexibility when needed to meet the government's requirements. In March 1996, the Department's Justice Management Division (JMD) contracted with a consulting firm that is available to provide assistance on management and financial issues to any government agency involved in the forfeiture process. This firm was used during the transition between the successor trustee and his replacement.15

To recruit a successor trustee, various Department components submitted names and recommendations of qualified individuals and advertisements were placed in the Wall Street Journal and New York Times. Applicants for the position were screened and interviewed by a panel from the USMS Office of General Counsel, USMS Seized Asset Division, USMS personnel from the Central District of California and personnel from the USAO's for the Southern District of Florida and the Central District of California.

While seeking and interviewing qualified candidates, the Department was debating how many trustees to propose. The USAO for the Southern District of Florida favored the appointment of both an operations trustee, to provide full-time oversight of day-to-day operations, and an administrative trustee, to provide administrative oversight of the LCP Partnership. The USMS Office of General Counsel proposed an alternative option that a successor trustee and a consultant to the trustee be selected.

Discussions and disagreements over this issue occurred among the USAO for the Southern District of Florida, the USMS General Counsel, other Department representatives, and the PPA Partnership. After a series of meetings, the component representatives decided that the USMS General Counsel would draft a court order for a single successor trustee. The successor trustee was selected in October 1992 with comments, advice and participation from the USMS, AFO and the USAOs for the Central District of California and the Southern District of Florida. The USMS Office of General Counsel did not act in a timely fashion in preparing the court order, thus delaying this task. As a result, the AFO eventually took on the task of drafting the order to appoint a successor trustee. The order was submitted to the court and approved in March 1993. The court order appointing the trustee broadly established the original duties and responsibilities of the successor trustee.

The duties of the successor trustee were expanded as various events occurred that left the positions of LCP general partner, joint venture administrative officer and Club general manager vacant. As a result, conflicts of interest arose with respect to various positions ultimately held by the successor trustee.

The Department encouraged the trustee's increasing authority and responsibility to the extent that by August 1994 he was: (1) successor trustee and sales broker for the government's portion of the LCP Partnership; (2) LCP general partner; (3) joint venture administrative officer; and (4) interim general manager. There are inherent conflicts of interest with the trustee holding these multiple positions. By holding the positions of general partner, administrative officer, and general manager the trustee was in the position of reviewing his own decisions, which themselves needed to be balanced among his responsibilities to the government, the LCP partners, the PPA partners, the club employees, the City of Bell Gardens, and customers. For example, the trustee's fiduciary responsibility to the other partners conflicts with his duty to sell the government's interest in the Club. The conflict exists because Club profits can be either distributed to partners or used to improve salability by increasing reserves or paying down debt.

The trustee acknowledged the inherent conflicts in his duties when he testified before the Senate Permanent Subcommittee on Investigations of the Committee of Government Affairs on March 19, 1996. He stated that "Because the Bicycle Club partners, the LCP, and PPA, have not always agreed on every issue, it has been my job to balance the interests of the Government with my fiduciary responsibilities to the other investors of the Club." During our audit, we could find no evidence that the USMS or other department representatives thoroughly analyzed the potential conflicts of interests or alternatives to utilizing the trustee for the vacant positions identified previously.

The successor trustee's salary for the first year was $116,610.16 The second year salary was approximately $200,000 and the third year $210,000, as approved by the court for each calendar year. We were told that the pay was determined by reviewing fees of other trustees in control of businesses of the same value. The trustee's salary was paid on a monthly basis by the USMS from income derived from the forfeited interest in the LCP Partnership. The table below details the trustee's salary and bonuses received from 1993 through 1995.

CALENDAR YEAR	SALARY	BONUS
1993	$ 116,610	0
1994	$ 199,992	54,958
1995	$ 210,000	112,500
Total	$ 526,602	167,458

In addition to a salary, the trustee also received bonus pay for his duties as the administrative officer. The payment of a bonus was set forth in the joint venture agreement. The bonuses were paid because in November 1993, the court also appointed the trustee to the position of joint venture administrative officer. Another court order stated that annual bonuses provided to the administrative officer would be shared equally by the government and the successor trustee. The court order did not prescribe who would pay the bonuses or their amounts. Information provided by the trustee in a December 1, 1995, deposition indicates that the bonus payments were authorized and approved by the Bicycle Club's senior management, which included the administrative officer, the trustee himself and two of his staff. We view the involvement of the trustee and his staff in setting the trustee's bonus for Administrative Officer duties as a conflict of interest. Representatives from Department components agreed to the bonus, and the Department shared in it per the court order.

On April 17, 1996, the State of California Attorney General's Office denied the license applications of three senior managers involved in the operations of the Bicycle Club. The State Attorney General also served the successor trustee with notice of its intention to withdraw his gaming license. The general manager, the Asian games manager and another employee were barred from entering the Club. Based on management disagreements and adverse publicity, the USMS, in consultation with the Deputy Attorney General's Office, agreed that it was not in the best interest of the government or the Club to retain the trustee. Therefore, the Department accepted the resignation of the successor trustee, effective upon selection of a replacement. Subsequently, the State of California and the successor trustee came to a settlement which resulted in no fines or other financial assessments being imposed on the trustee and contained no findings of wrongdoing.

Upon the resignation of the successor trustee, the Department selected another court-appointed trustee. The court approved the replacement successor trustee in June 1996, with an effective date of the previous month. In the interim, the USMS retained a certified public accounting firm, with special expertise in the security aspects of gaming casino operations, to oversee daily operations of the Club. The firm was obtained through the JMD management contract previously discussed under "Successor Trustee."

The court order specifies that the replacement successor trustee is to act on the government's behalf as its agent in the capacities of the general partner of LCP and a limited partner in LCP and further to exercise the attendant functions, duties, and responsibilities of those positions and interests. Those functions, duties, and responsibilities include, but are not limited to, oversight of the business and general operations of the Bicycle Club and supervision of the Club's general manager and other management employees. The replacement successor trustee also has the authority to act on behalf of the government to arrange for the sale of the government's interest in the Club subject to the government's final approval. The court order further specifies that the replacement successor trustee: (1) be compensated at his normal hourly rate of $350 per hour; (2) may engage in other professional work not materially interfering or inconsistent with the execution of his responsibilities; and (3) has the power to employ and compensate other professionals, including lawyers, to assist him in carrying out his duties in consultation with the USMS.

The replacement successor trustee's compensation for 1996 and 1997 appears in the tables that follow. The USMS and the replacement successor trustee initially expected that he would devote full-time efforts to the Club for the first quarter and would thereafter fulfill his duties on a part-time basis.

DATE	HOURS	RATE	TOTAL BILLED
May & June 96	386	$ 350	$ 125,100 17
July 96	268.6	350	$ 94,010
August 96	208	350	$ 72,800
September 96	138	350	$ 48,300
October, 96	171	350	$ 59,850
November, 96	128.5	350	$ 44,975
December 96	121	350	$ 42,350
Total 1996	1,421.1		$ 487,385

DATE	HOURS18	RATE	TOTAL BILLED
January 97	182	$ 350	$ 63,700
February 97	148	350	$ 51,800
March 97	194	350	$ 67,900
April 97	194	350	$ 56,000
May 97	159	350	$ 55,650
June 97	219	350	$ 56,000
July 97	171.5	350	$ 56,000
Total 1997 (through July)	1,267.5		$ 407,050

In addition to the trustee's earnings detailed above, the trustee billed and the USMS paid about $535,000 from May to December of 1996 (an average of about $67,000 per month) and $130,000 from January to July 1997 (an average of about $18,500 per month) to law firms for legal work related to the Bicycle Club, including meetings and telephone conferences relating to disposal of the Club. The trustee also received a total of over $40,000 for phone charges, travel, insurance, a car allowance and other business fees in 1996 and 1997. Appendix IV contains a more detailed accounting of trustee expenses and a comparison to net monthly distributions received by the USMS from Club operations for 1996 and 1997 to date. From May 1996 through July 1997, the replacement successor trustee's total compensation and expenses represented about one-half of the income the government received from the Club during this time.

In our judgment, the current open-ended compensation arrangement does not provide sufficient confidence that the funds paid to the trustee are well spent. The unlimited potential compensation to the trustee creates at least the appearance of a conflict of interest because the trustee also has responsibility to assist in selling the casino. In the future, the tasks of managing and disposing of these types of assets should be segregated and, absent unusual circumstances, left to experts under contract with the USMS.

The USMS has taken some steps in an attempt to decrease the trustee's compensation, although the Deputy Attorney General's office and ultimately the court also have decision making authority. In September 1996 the trustee voluntarily agreed to try to minimize the use of senior lawyers. As previously mentioned, the trustee voluntarily agreed to limit his monthly billings, although he may recoup the hours over the cap in later months.19 In June 1997, the trustee began to retroactively allocate expenses previously billed only to the government to the Bicycle Club. According to the USMS, as of October 1997, the trustee indicated that he would repay the government at least $407,476.20 Although this has not necessarily limited the trustee's overall compensation and expenses, it will cut the government's share of these amounts by about 25 percent, once it is received by the USMS.

In our judgment, since the trustee is court-appointed and has broad authority and duties, it is difficult for the Department to successfully contest billings. If the current trustee was a contractor working for the Department, with specific written duties, we would recommend a formal audit of all billings. However, for this asset, the USMS and the trustee have a written agreement that limits the time period the USMS has to contest billings to 30 days. Therefore, other than requesting that the court terminate the trustee, we believe that the only option available to the USMS is to continue to review all trustee billings before they are paid, challenge them when appropriate, and negotiate concessions when required. In the future, the Department should avoid broad agreements for services and open-ended compensation arrangements limiting the government's ability to contest billings.

We discussed our findings and recommendations with Department officials. An official from the Deputy Attorney General's office stated that court-appointed trustees should not be used for asset management and disposition except in rare instances, and that the Bicycle Club was one of those instances. The DAG official stated that a court-appointed trustee was necessary in this case because: (1) the court-appointed trustee probably cost less than hiring a contractor, (2) it would have been difficult to find a qualified contractor willing to take the job given the problems involved and the potential liability from lawsuits21, and (3) it was advantageous to have all litigation matters presented to a single, knowledgeable court. An official from the USAO Central District of California agreed and stated that the utilization of a court appointed trustee has proven to be an important shield, insulating the government from liability to the non-government partners, the original Club manager, and the municipality in which the Club is located.

An official with the USMS generally agreed that the court should not be involved in the Department's responsibility to manage and dispose of seized assets, but stated that if ever there were a case which called for the continuing use of a trustee, it is the Bicycle Club. The Club is a heavily regulated activity, with a complex joint federal-private ownership interest. Only a court supervised trustee could have exercised the ownership powers of the United States without exposing the federal government and its employees to extraordinary potential liability and a collision with the California Attorney General over whether these employees would be subject to California registration and sanctions. The use of a registered, court supervised trustee obviated these concerns and many others, while assuring innocent parties a neutral forum in which to raise their objections over the administration of the assets held by the United States in this case.

The USMS official also stated that the successor trustee's increases in salary dovetailed with increases in responsibility and positions held. Although the government recognized the possibility of conflicts in the position held temporarily by the (second) successor trustee, e.g., general manager, the Club was struggling to fill the general manager position, and needed an experienced, knowledgeable person to perform the duties while the position remained vacant.

The USMS stated that since the appointment of the (third) replacement successor trustee, there has been a dramatic increase in the level of trustee oversight. Although the current fees and expenses of the trustee are high in historical terms, the trustee has faced many more legal challenges. He has shepherded the most complex business transaction in the history of the asset forfeiture program toward what now appears to be a successful conclusion. Measured against the value of the transaction, its complexity, the litigiousness of the opponents of the transaction and the oversight of numerous, extraordinary and costly legal challenges to the Bicycle Club, the trustee's fees cannot be said to be unreasonably excessive. More importantly, the trustee has capped his fees on a monthly basis and at the USMS' urging has reduced his use of his most expensive legal advisors, moving more work to other firms, which voluntarily discounted charges and wrote off time charges before the current trustee's appointment.

The Department's involvement with this asset has been a long, complex, and unique experience. The appointment of the interim trustee by the court was necessary considering the litigation stemming from the Department's seizure of the entire business and the need to protect innocent third parties. The court's involvement may have been unnecessary if the USAO for the Southern District of Florida had performed better preseizure planning and not seized the entire Club. After it was decided to replace the first court-appointed trustee, the Department could have moved to contractors to manage and dispose of the asset. However, we cannot say with certainty whether using court-appointed trustees has been an overall advantage or disadvantage. Generally, however, we believe that using contractors is preferable to involvement of the court because it is easier to control duties, performance, length of employment, and cost.

During our audit, we identified problems with these issues. The court-appointed trustee duties are broad and it can be difficult to control the court-appointed trustee's actions. This was particularly true for the Department in dealing with the successor trustee who on several occasions did not act in consultation with the Department. Instead of being able to terminate the court-appointed trustee immediately, the Department had to ask him to resign and obtain court approval. Broad duties also invite at least the potential for conflicts of interest. The interim trustee was both the on-site representative for the USMS and the Finance Director for the City of Bell Gardens. The successor trustee was sales broker for the government's interest in the Club, the LCP general partner, the joint venture administrative officer, and the Club's general manager, in addition to conducting his regular trustee duties. We found no evidence to indicate that the Department thoroughly evaluated the trustees' broad, court-appointed duties to ensure that there were no potential conflicts of interest.

The latest example of a potential conflict involves the current trustee's unlimited compensation arrangement and his duties to manage and assist in the sale of the government's interest in the casino. In the future, the Department should avoid this kind of arrangement by separating the duties of managing and disposing of the asset. Although it may be more expensive in the short term, the disposal of assets would limit conflict of interest concerns if the broker is paid by a commission instead of a salary. Use of brokers could also help to hasten the sale of assets and control disposal costs because the Department would typically not incur substantial costs unless and until the asset is sold.

6. Use contractors in the future to manage complex assets unless special circumstances dictate otherwise. The tasks of managing and disposing of the asset should be separated and include an incentive for quick disposal.

Resolved. In order to close this recommendation, please provide documentation indicating this policy has been implemented.

7. Avoid open-ended compensation arrangements in the future for asset management and/or disposal.

Resolved. In order to close this recommendation, please provide documentation indicating this policy has been implemented.

8. Carefully review all billings by the replacement successor trustee and continue to contest them when necessary.

Resolved. In order to close this recommendation, please provide documentation indicating that billings continue to be reviewed.

To determine the adequacy of USMS management of seized assets, including the Bicycle Club, we reviewed and analyzed (1) previous studies and reports and (2) monthly distributions to the USMS as reported by the successor trustee.

USMS concerns about the management of day-to-day operations of the Club and the large monetary value of the asset prompted several reviews of the asset, Club business procedures, and trustee expenses. The following is a brief summary of each report that addressed USMS oversight of the asset.

Additional reports on the Club's operation were performed by consultants Kenneth Leventhal and Company in 1992 and John Van de Kamp in 1995. These reviews noted many internal control problems, including inadequate segregation of duties in high-risk areas and problems with cash handling.

In addition, numerous government reports, including General Accounting Office (GAO) and Office of the Inspector General reports, have been issued in the last several years criticizing various aspects of the USMS management of forfeited assets (see Appendix V).

Collectively, these reports highlight the serious, unique and persistent problems that can occur in the long-term ownership and operation of a complex, ongoing business.

In addition to reviewing and analyzing prior reports, we also performed financial testing of USMS controls over the receipt of partnership shares in connection with the Bicycle Club. Specifically, we reviewed the monthly "LCP Partnership Distribution" schedules as they were set forth in the trustees' monthly reports. We traced these distributions through receipt and deposit by the USMS to determine if all distributions were received and deposited.

A total of 88 cash receipts were recorded as deposited into the Asset Forfeiture Fund as of January 1996 with a total value of $40.6 million. We traced a sample of 55 partnership distributions from the trustees' reports to the USMS accounting records for seized funds and to the Treasury account for seized funds. The 55 receipts represented a value of $31.6 million or 78 percent of the total amount recorded. Initially, we could not trace two partnership distributions, totaling $1.6 million. The amounts involved were:

December 1991 LCP Share	$ 1,170,000
May 1994 USMS Share	$ 424,865

Despite several attempts, we were unable to determine the status of these funds by reviewing USMS accounting records. Ultimately, we were able to trace the funds by obtaining documentation from the Bicycle Club. Accordingly, our testing established that of the sample of partnership distributions tested, all were received and deposited.

We discussed our findings with Department officials. According to the USMS, it has not had oversight of the replacement successor trustee since March 1996 when oversight was transferred to the DAG's office. The officials stated that the USMS recognized the need to further strengthen its control over trustees. The USMS has developed a full array of policies and procedures to improve trustee controls, but these have not been adopted due to lengthy internal review within the Department.

The officials also noted that the USMS Director has consistently maintained that the Department's Executive Office for United States Trustees (EOUST) should be given primary role of oversight of forfeiture trustees. Their expertise in the oversight of bankruptcy trustees makes them uniquely qualified to fill this role. The EOUST has been extremely helpful in providing technical assistance, and the USMS has relied heavily on their advice in drafting the documents that are still being reviewed in the Department. The proposal remains a subject of discussion among Department components.

In addition, the USMS stated it has centralized management of businesses and trustees. It is finalizing the hiring of a business manager to fill this role. In the meantime, the USMS continues to use the services of a management consultant with extensive private sector business experience.

Because recommendations were made in previous reports to correct the internal control environment, we offer no formal recommendations here. However, the USMS needs to complete corrective action to ensure that the deficiencies noted in the prior reports and reviews do not recur.

In our judgment, the task of managing and disposing of the Bicycle Club has presented a unique challenge. The gaming business is a competitive, unique industry that requires a high level of specialized expertise to manage a going concern effectively. The Bicycle Club's business organization and legal structure are also unique and complex. Nevertheless, the Department unnecessarily compounded these issues by poor internal communication, inaction and bad decisions.

An important overall question is whether the Department's involvement with the Bicycle Club has been handled in the best interests of the taxpayer. Determining this depends on how overall success is measured.

Ultimately, success will be determined by a combination of the above criteria and the answer will likely be somewhere between the extremes. Although this report is based on our review of one asset, it provides lessons for managing problem assets in the future.

16 The approved salary was $150,000 per year. However, the successor trustee was paid $116,610 for about 9 months.

17 For May through June 1996, the trustee billed $125,100 instead of $135,100 (386 hours multiplied by $350 per hour).

18 Beginning in April 1997 the trustee voluntarily limited the maximum monthly billing to 160 hours. However, any amount over 160 hours that is worked but not billed may be recouped at a later time. In November 1997, the trustee proposed raising his voluntary monthly billing cap to 173 hours. According to the USMS, as of January 1998, it had not agreed to the proposal.

19 If adhered to, the April 1997 cap would result in a maximum annual salary of $672,000. If the USMS accepts the revised monthly cap proposed by the trustee in November 1997, it would result in a maximum annual salary of about $728,000.

21 The government has indemnified the current trustee from possible lawsuits for an unlimited amount.