Trustee’s report blames Myrtle Beach-based Direct Air’s founders for nearly $30.4 million in missing escrow funds
03/12/2014 10:27 AM
03/12/2014 10:28 AM
Myrtle Beach-based Direct Air’s founders took more than $30 million from the charter air carrier’s escrow account through a series of fraudulent and improper bank transactions, according to a bankruptcy trustee’s report, but it appears all of the money went to pay the financially struggling carrier’s bills.
The report, released this month, paints a picture of a poorly run business that always operated at a loss and whose founders didn’t realize the carrier’s escrow account had a shortfall until more than two years after Direct Air started flying, even though the information was readily available to them. Even when the shortfall was discovered, the carrier’s founders repeatedly underestimated the missing funds by tens of millions of dollars, the report states.
Trustee Joseph Baldiga said he will be filing complaints against Direct Air’s founders to recover funds that were taken through fraudulent bank transactions. Direct Air’s founders include: Judy Tull, Ed Warneck, Robert Keilman, Kay Ellison and Stanley Marshall Ellison.
Baldiga declined to say whether he plans to turn his findings over to law enforcement for further investigation.
Reese Boyd III, a lawyer representing Tull and the Ellisons, said Baldiga’s report “contains quite a few inaccuracies that my clients do not agree with.”
“My clients feel they presented documentation that showed evidence contrary to what is in the report,” Boyd said, adding that Tull and the Ellisons plan to respond to the allegations. Boyd declined to comment further, citing ongoing proceedings in the case.
Warneck and a lawyer representing Keilman could not be reached for comment Wednesday.
The report also blames Valley National Bank, the bank that held Direct Air’s escrow account, for failing to question any of the withdrawal requests made by Direct Air’s founders.
“Valley National Bank never failed to process any release report submitted by Direct Air,” Baldiga said in the report.
The report exonerates Avondale Ventures LLC, a private-equity firm that bought 55 percent of Direct Air in September 2011 – just six months before the charter carrier filed for bankruptcy protection. Baldiga said in his report that Hank Torbert, Avondale’s founder, had no access to Direct Air’s escrow account until two days before the bankruptcy filing. By that time, the money had already been drained from the account.
Tull said in a 2012 interview with a Worcester, Mass., newspaper that Torbert and Avondale “have been running the company since September , making all the financial decisions.”
Baldiga’s report disputes that, saying “[Kay] Ellison and Tull continued to exclusively manage Direct Air’s relationship with Valley National Bank” and that Ellison repeatedly refused to provide financial information to Torbert and Avondale executives.
The report states that Direct Air’s founders kept the escrow shortfall a secret from its staff, legal counsel, creditors and banks. However, the founders did not appear to benefit directly from the fraudulent transfers other than their normal compensation.
“There is no evidence of money transfers to offshore accounts or large amounts of unidentified cash withdrawals from Direct Air’s bank accounts,” Baldiga said in the report.
How the money disappeared
By the time Direct Air filed for bankruptcy protection in March 2012, the shortfall in the carrier’s escrow account totaled nearly $30.4 million. Federal law required Direct Air to establish the escrow account so passengers’ fares would be protected if a flight did not occur. Once a flight took place, the escrowed money could be withdrawn by Direct Air to pay bills.
Baldiga’s report identifies three ways in which Direct Air’s founders improperly drained the escrow account.
Among those was the founders’ practice of over-reporting passenger revenues for individual flights by adding passengers to its reporting system who actually never took the flight. Those “ghost passengers” falsely inflated the revenue figures Direct Air reported to the bank holding its escrow account, allowing Direct Air to withdraw more money per flight than it should have been allowed to take.
Penelope Bley, a forensic accountant who investigated Direct Air’s finances, stated in an affidavit that she identified 64,172 instances in which the carrier’s executives used “ghost passengers” to inflate revenue figures. That allowed those executives to improperly withdraw more than $8.3 million from the escrow account.
Another way the escrow funds were taken involved the carrier’s Family Ties program, which allowed customers to purchase low-priced vouchers for any upcoming flight. Each voucher included a membership fee that ranged from $40 to $60. Direct Air’s founders believed the membership fee portion of the voucher did not have to be kept in escrow, so those fees were immediately withdrawn. Then, after the flights took place, Direct Air withdrew the full voucher total which included the membership fee.
“That resulted in Direct Air being paid twice from the depository accounts … for Family Ties membership fees,” the report states.
Nearly $12.2 million was improperly taken from the escrow account through the Family Ties withdrawals, according to the report.
A third way money was taken improperly was through withdrawal requests Direct Air’s founders made for funds they never actually deposited into the Valley National Bank escrow account. For example, Direct Air’s founders would file withdrawal requests for passenger fares paid with cash even though cash payments were not deposited into the escrow account. The bank gave that money to Direct Air’s founders even though it knew cash was never deposited into the account.
There were 188 of those release requests totaling more than $5.5 million, according to the report.
Baldiga said in the report that he was not able to determine where another $4.3 million of escrow funds went because the forensic accounting necessary would have been too time-consuming.
“Determining the source of the remaining shortfall with certainty would require in-depth review and analysis of each release request and customer records,” Baldiga said.
Baldiga’s office has been working on the report for nearly two years, since shortly after Direct Air filed for bankruptcy protection.
Distrust and ‘silent partners’
Court documents and depositions in the bankruptcy case show Direct Air’s founders had no idea how much money was really missing from the escrow account even as the charter carrier skidded toward bankruptcy. Those court filings also provide insight into growing distrust and animosity between the carrier’s founders.
For example, Tull said in the 2012 newspaper interview that Torbert had fired her shortly before the bankruptcy filing. However, Torbert – during a creditors’ meeting – said Tull quit because he wanted Kay Ellison to take over as Direct Air’s spokeswoman.
“We asked there be one point person that filters everything through to workers and management team,” Torbert said during the hearing, adding that he asked Kay Ellison to take that role. “Miss Tull … expressed deep concerns with that decision with Kay Ellison. So did Mr. Warneck. . . . At that point I asked her [Tull], ‘Well, are you resigning from the company?’ and she said, ‘Yes, I am.’ ”
Warneck, who was in charge of marketing the charter service, said during his deposition that he did not trust Tull and Kay Ellison and that the two women would override his marketing decisions.
“They would micromanage and go around me to work with my staff, you know,” Warneck said.
Finally, as the charter service was near failure, Warneck said Tull and Kay Ellison “walked out,” leaving him to face unpaid creditors including marketing groups with which he had longstanding relationships.
“I was left holding the bag and facing the music here, and that’s when my eyes really became open as to what was going on here,” Warneck said during his deposition. “I mean, their character showed. I face the music every day in this community and it’s very, very difficult.”
Boyd, in a December letter to the trustee’s lawyer, said Warneck’s statements were inaccurate.
“There were often disagreements, but the five founding members would meet, and would determine a course of action,” Boyd wrote. “No areas of the business were shielded or departmentalized away from any of the founding members.”
The court documents also show how Direct Air obtained its initial $400,000 in financing in 2006 to get off the ground. Keilman, one of the carrier’s founders and a former senior vice president at Bank of New York, put up $100,000 of his money after being recruited by Warneck to join Direct Air’s management team.
The charter service also had three “silent partners” who paid $100,000 apiece for 3 percent stakes in Direct Air. Those partners included: hotel owner Jim Creel; hotel and golf course owner Matthew Brittain; and golf course owner Larry Young. It’s not clear what, if any, benefits those partners received from their investment in Direct Air. Keilman said in his deposition that there was no formal agreement between the carrier and the “silent partners” over how or whether they would ever be paid.
“There was no expectations, nor were any promises made to them, about how they would get repaid,” Keilman said.
Creel, Brittain and Young could not be reached for comment on Wednesday.
Direct Air – which was formed to help bring tourists to the Myrtle Beach area – announced in 2006 that it would start offering air charter services with its first flight on March 7, 2007. The charter service stopped flying five years later after running up $80 million in unpaid bills, according to bankruptcy documents. Direct Air accounted for more than 10 percent of all traffic at Myrtle Beach International Airport in the year before it abruptly stopped flying tourists from 17 destinations.
There were about 93,000 people who bought tickets for Direct Air flights that did not occur. Most of those people received refunds through credit card chargebacks. The bank that handled those chargebacks is suing Direct Air’s founders to get back about $25 million it lost due to the refunds. A bankruptcy judge also approved $250,000 in payments to passengers who bought tickets with cash or other means instead of a credit card.
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