One of the most hotly contested issues in Ponzi scheme
cases is how to distribute to the defrauded investors the funds that are
ultimately recovered. It often seems that no two investors are created equal,
so their interests are pitted against one another in the pursuit of "equity."
Designing the most equitable plan for the distribution of
the remaining assets to defrauded investors in a Ponzi scheme case is
challenging, to say the least. Someone always ends up unhappy. How do you
calculate the loss amount, and then how do you treat the amounts withdrawn by
investors during the course of the Ponzi scheme? Some investors received
partial payments, some investors received full reimbursement of their principal
investment, some received profits as well, and others got absolutely nothing
How should a receiver allocate the available cash among
these different categories of investors? And does the selected distribution
plan impact investor behavior in future Ponzi scheme cases?
The Seventh Circuit recently affirmed the Rising Tide methodology
for the distribution of the remaining funds in the receiver's possession at the
end of the receiver's administration in the Ponzi scheme case run by William
Huber. SEC v. Huber, 2012 U.S. App. LEXIS 24547 (7th Cir. Nov. 29, 2012).
Huber was sentenced to 20 years in prison for his scheme that defrauded 118
investors of $22.6 million. United States v. Huber, 455 Fed. App'x 696,
697 (7th Cir. 2012).
In that case, the receiver had the choice of distributing
the remaining $1 million to the investors on a pro rata basis, or treating the
11 investors that had already received money as withdrawals from the scheme on
a different basis. The receiver chose the latter distribution plan and obtained
the approval of the district court to count the withdrawals to those 11
investors as partial compensation for those investors' losses. The court had
adopted the "Rising Tide" method, rather than using the "Net Loss" method.
On appeal, the Seventh Circuit stated, "Under the rising
tide method, withdrawals are considered part of the distribution received by an
investor and so are subtracted from the amount of the receivership assets to
which he would be entitled had there been no withdrawals. (When there are no
withdrawals, rising tide yields the same distribution of receivership assets as
net loss.)" SEC v. Huber, 2012 U.S. App. LEXIS 24547, at *3-4.
The Method of Calculation
The Seventh Circuit described the difference between the Rising
Tide method and the Net Loss methods as follows:
To understand the difference between the two methods,
imagine that three investors lose money in a Ponzi scheme. A invested
$150,000 and withdrew $60,000 before the scheme collapsed, so his net loss was
$90,000. B invested $150,000 but withdrew only $30,000; his net loss was
$120,000. C invested $150,000 and withdrew nothing, so lost $150,000.
Suppose the receiver gets hold of $60,000 in assets of the Ponzi scheme--one-sixth
of the total loss of $360,000 incurred by the three investors ($90,000 +
$120,000 + $150,000). We'll call these recovered assets "receivership assets."
Under the net loss method each investor would receive a sixth of his loss, so A
would receive $15,000, B $20,000, and C $25,000 . . .
The mathematical calculations can get complicated under
the Rising Tide method, but are designed to bring the total distributions made
to investors (including both amounts withdrawn during the scheme and amounts to
be distributed to by the receiver) as close to each other as possible. The Seventh Circuit described this process as
In our example, the total of withdrawn plus receivership
assets is $150,000 ($60,000 + $30,000 + $0 [the withdrawals] + $60,000 [the
receivership assets]), but there is only the $60,000 in such assets to distribute.
A, having been deemed (as a consequence of the rising tide approach) to
have "recovered" $60,000 before the collapse of the Ponzi scheme, is entitled to nothing
from the receiver, as otherwise the remaining sum of withdrawals and
receivership assets--a total of $90,000 ($30,000 in withdrawals, all by B,
and $60,000 in receivership assets)--would be insufficient to bring the
remaining investors up to anywhere near A's level. For remember that
under the net loss method each investor would have received the same fraction
of receivership assets as his fraction of the loss, and thus A would
have received $15,000, B $20,000, and C $25,000. The result,
since under the rising tide method withdrawals are treated as compensation, is
that A would have been "compensated" to the tune of $75,000 ($60,000 withdrawn
+ $15,000 in receiver assets), B $50,000 ($30,000 + $20,000), and C
$25,000 (the balance of receiver assets, C having had no withdrawals).
The result of the Rising Tide method of distribution is
that those investors who received payments during the Ponzi scheme will receive
a lower percentage dividend at the time of the receiver's distribution. Despite
this disparate treatment at the end of the case, the Seventh Circuit affirmed
the use of the Rising Tide method, noting that it is "the method most commonly
used (and judicially approved) for apportioning receivership assets." Id. at *5.
The Equities of the Chosen Method of
Those investors who received payments during the Ponzi
scheme argue against the Rising Tide method, commenting that they should not be
penalized for having withdrawn some of their money.
The Seventh Circuit analyzed how the ultimate
distribution plan in a Ponzi scheme case might affect the behavior of Ponzi
scheme investors. For example, if Rising Tide methods were adopted, this would
discourage "partial exit in the form of withdrawals because withdrawers are
denied any further recovery." Id. at
*7. However, as the court observed, "it also encourages a withdrawer to
withdraw his entire investment, since he won't be treated as well in the
distribution of receiver assets if it turns out that he invested in a Ponzi
scheme." Id. at *7.
The court also considered how the equities of a
particular case might lead to a different conclusion. For example, if the facts
of the case were that a large number of investors would receive nothing under
the Rising Tide method, i.e., 45 to 55%, then the net loss method might be
preferred. Id. at *8.
The battles among different categories of investors
continues as receivers, trustees, and courts struggle with how to balance the
interests of investors who have been defrauded, only some of which have already
received money back from the Ponzi schemer. While it is clear that there is not
a one size fits all answer to the question, it is quite unclear whether the
selected distribution plan has any impact on future Ponzi scheme cases. The
Seventh Circuit's focus on deterrence begs the question of whether an investor
is at all impacted by what has happened in Ponzi scheme cases before it in
making the decision to withdraw funds from an investment program.
The Rising Tide method of distribution as well as other
methods of distribution are discussed at length in The Ponzi Book: A Legal Resource
for Unraveling Ponzi Schemes, §20.04 and Appendix 1.
subscribers can access enhanced versions of the opinions cited in this article:
v. Huber, 2012 U.S. App.
LEXIS 24547 (7th Cir. Nov. 29, 2012)
States v. Huber, 455 Fed. App'x 696, 697 (7th Cir. 2012)
Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal
Resource for Unraveling Ponzi Schemes (LexisNexis 2012), along with
Hon. Steven Rhodes. The Ponzi Book, recently reviewed by Commercial Crime International, is
available for purchase at www.lexisnexis.com/ponzibook, and more information about
the book can be found at www.theponzibook.com.
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