Seth Sandronsky Jun. 2, 2016, 11:28am

SAN FRANCISCO (Legal Newsline) - A San Francisco-based litigation funding company is a type of business that operates in the shadows, according to a legal expert, and now that the Securities Exchange Commission is going after Prometheus Law on charges of defrauding investors, other third-party litigation funders may find themselves subject to greater oversight.

“Litigation funding is a shadow industry," professor Maya Steinitz of the University of Iowa, College of Law, told the Northern California Record. “So there's no data on how widespread any practice is, and (it) speaks of the need to have some kind of regulatory oversight over litigation finance.”

In charges filed April 16 in the Central District of California, Prometheus executives James Catipay and David Aldrich are alleged to have violated six SEC rules in raising nearly $12 million from about 250 investors since 2013. The firm allegedly engaged in an illegal scheme to profit from prospective plaintiffs’ personal injury lawsuits over medical equipment and prescription drugs. 

Steinitz said that as the functions of third party litigation businesses become more visible, “there will probably be more outlier cases of abuse that need to be addressed by the SEC and others." 

"I have long argued that we should focus on litigation finance as a form of finance and regulate it as a pocket of the finance industry rather than to focus exclusively on stretching the regulation of attorneys to address potential abuses,”  she said. 

Steinitz participated in a 2013 panel on litigation financing at Stanford University and has published two articles on the subject, “A Model Litigation Finance Contract," and "Whose Claim is This Anyway?"

A statement from Michele W. Layne, director of the SEC’s Los Angeles regional office, says the company "defrauded investors, many of them retirees, by repeatedly downplaying the risks associated with their investments and the fact that their entire business model was unrealistic to afford the exorbitant returns promised."

Catipay, a tax attorney, and Aldrich, company president and marketing officer, allegedly promised returns of 100 percent to 300 percent to investors, based on the future proceeds of settlements from plaintiffs’ class-action personal injury lawsuits. Investments of a penny that reaped returns $1 to $3 never arrived, authorities say. 

Instead, Prometheus Law’s initial investors received income from more recent investors. 

Prometheus owes investors $31.5 million, according to the SEC. It seeks preliminary and permanent injunctions, an appointed receiver over the firm and a freeze of assets.   

Kim Stone, president of the California Civil Justice Association, said that third-party litigation financing with respect to mass tort actions raises serious concerns.

“If the class action lawsuit is funded by an outside party and is pushed by a lawyer, then what role if any does the supposed client play?” she said. 

And, how widespread is such wrongdoing as the SEC alleges in charges against Prometheus Law?

Morris Ratner, associate professor at University of California Hastings College of Law in San Francisco, warned investors of potential downsides of investing in litigation funding.

“As with any type of investment,” he said, “there will be persons who misuse capital that they raise or engage in other kinds of fraud, and they will be subject to SEC actions, private litigation, and the like."

“I don't have any reason to believe that fraud is any more common in third-party funding than it is in any other investment domain,” Ratner said.

But, he said, what is arguably different with third party litigation funding is that the field is poorly understood by some investors.

It also has "received substantial media coverage for being lucrative, two things that make it ripe for fraud. Litigation funding is an evolving field," Ratner said.

He added that there are established players that dominate the field - such as New York-based Burford Capital - which he said will likely not experience "any impact at all from the SEC's investigation of Prometheus.”

 According to its website, Burford “is the world's largest provider of finance for litigation and arbitration–our capital can be used for case or portfolio funding, operating expenses, and more." 

“Burford’s 2016 Litigation Finance Survey shows that litigation finance continues to grow and evolve, with 28 percent of private practice lawyers (who) say their firms have used litigation finance directly—a four-fold increase since 2013." 

Chicago-based litigation funder Gerchen Keller Capital also claims to be the world's largest provider of such legal financing, with more than $1.4 billion in assets. In 2013, Gerchen Keller says it had more than $100 million in capital. 

Judith A. Butler, an SEC spokesperson, declined a request from the Northern California Record for a comment on how widespread the alleged wrongdoing by Prometheus Law is, and if more third-party litigation SEC suits are ahead. 

More News