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Aftermath of a Ponzi scheme collapse

Ponzi Scheme

Since the Bernie Madoff scandal grabbed headlines several years ago, investors have become more aware of what a Ponzi scheme is and how they operate. While the Madoff scandal was big news, most people don’t realize that at any given time in this country, there are countless Ponzi schemes being perpetuated against unsuspecting investors.

Once the scheme itself unravels – and they always do – investors are left asking themselves: how can I get my money back?

A Ponzi scheme is a fraudulent investment operation that pays “returns” to investors from their own money or money paid by later investors rather than from actual earned revenue. These schemes are illegal and operate on the “rob-Peter-to-pay-Paul” principle, as money from new investors is used to pay off the previous investors. The continuous and destructive cycle eventually falls apart when not enough new investors can be found.

Oftentimes, the Ponzi schemer is associated with a registered brokerage firm at the time he operates the scam. There are two theories under which a brokerage firm may be liable to investors for its broker’s Ponzi scheme.

First, although the firm may claim to be unaware that one of its brokers is offering unlicensed and unlawful securities (known as “selling away”), brokerage firms have a duty to supervise the actions of their brokers. The brokerage firm can be held responsible for the losses sustained by victims of the fraud if the firm failed to adequately supervise its broker. Brokerage firms cannot turn a blind eye while their representatives sell sham investments or otherwise run rampant with their customers’ assets. Rather, the firms have an affirmative duty to implement and operate robust supervisory systems that adequately monitor and detect this type of misconduct. This means that the brokerage firm can be forced to pay for the losses suffered by investors in the Ponzi scheme, even if the brokerage firm was unaware of the broker’s misconduct.

The second theory of liability for brokerage firm liability is under a state’s securities laws. Every state has its own securities law statute, often known as “blue sky laws.” While the laws vary from state to state, all states require registration of securities offerings, brokerage firms, and brokers. All states’ securities statutes prohibit fraud in the sale of securities. A traditional Ponzi scheme typically carries multiple state securities laws violations, being that the whole system is a scam and the securities being sold undoubtedly are not properly registered with the state. The question then becomes which parties can be held liable under the appropriate state’s securities laws.

In Ohio, as one example, every person who has participated in or aided the seller in any way in making a sale that violates the act are liable to the purchaser. Some states provide that if an entity receives any compensation for the fraud, whether directly or indirectly, that entity may be civilly liable. It is hard to imagine a scenario where a schemer is able to conduct his illegal business without using one or more banks or financial institutions. A financial institution that accepts compensation, ignores red flags, and is essentially complicit in the scheme can potentially be held liable under a state’s securities laws for its aid to the schemer.

Many Ponzi scheme victims understandably want to file civil claims directly against the Ponzi schemer. From a practical standpoint, however, such an approach often makes little sense. Once Ponzi schemers are discovered, it is usually the case that the schemer has spent all or most of the money. So while the victim could certainly sue the Ponzi schemer and very likely win a judgment against them in court, it’s unlikely that the victim will recover any money at the end of the day.

In the right circumstances investors are much more likely to recover their losses by focusing their cases on the supervising brokerage firms and other third parties that may be held legally responsible for the Ponzi schemers’ misconduct and that have the financial ability to pay a judgment.

When Ponzi schemes eventually collapse and the perpetrators are caught, there are usually separate criminal proceedings brought against the Ponzi schemer. Additionally, there are often separate receivership actions in which courts appoint a person called a receiver to gather the Ponzi schemers’ remaining assets. Ultimately, whatever assets are collected are eventually distributed to creditors, including investor victims. The receivers typically establish a claims process requiring victims to prove their losses in the scheme.

While these proceedings serve important purposes, they generally do not result in making the Ponzi scheme victims whole. In many cases, Ponzi scheme victims get very little of their money back from criminal courts or court-appointed receivers.

At the end of the day, for investors who have lost money as a result of a Ponzi scheme, there are two steps that should be taken. First, gather any paperwork, checks, correspondence, or other records relating to the investments and/or any returns from scheme. Then, investors should contact an experienced securities fraud lawyer.

Because securities fraud cases are generally handled through mandatory binding arbitration rather than through a classic courtroom trial, the attorney handling your case needs to possess very specific knowledge and experience in this niche area of the law to have the best chance of a successful outcome.

David P. Meyer David P. Meyer is the founding principal of the law firm of Meyer Wilson Co., LPA. With offices in Ohio and California, the firm is devoted solely to the representation of individual investors who have been the victims of investment misconduct and the prosecution of consumer class actions.