How to Divide the Remaining Sliver of Pie in Ponzi Cases: Claims Allowance and Distribution Schemes

How to Divide the Remaining Sliver of Pie in Ponzi Cases: Claims Allowance and Distribution Schemes

by Kathy Bazoian Phelps and Hon. Steven Rhodes

This Emerging Issues Analysis has been adapted from material appearing in The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes (LexisNexis 2012), by Kathy Bazoian Phelps and Hon. Steven Rhodes.

The goal of case administration in a Ponzi scheme (whether in bankruptcy or under SIPA) is claims allowance and distribution. In this Emerging Issues Analysis, the authors provide an overview of the conflicts inherent in distributing recovered funds to Ponzi victims. Given that each victim cannot be compensated in full, all that can be hoped for is the "least unfair" distribution plan. Most courts have been flexible in their approach.

Excerpt:

A receiver and a trustee in a Ponzi scheme case ultimately must face the task of distributing funds recovered in the course of administration. For defrauded investors and other creditors, the claims allowance and distribution process is the whole point of the insolvency proceeding. The process is complicated and destined to create conflict as no claims allowance and distribution process can be uniformly equitable. "When . . . there is 'a small pie and many disappointed investors,' there is an inherent conflict among investors." "The only way to treat the victims fairly would be for each and every victim to be repaid in full. Unfortunately, this is impossible. It is the task of this court to choose not what is the 'fairest' distribution plan, but to choose the plan which is the least unfair."

The nature of claims asserted in Ponzi cases is varied. Investor claims can range from investors who used the Ponzi debtor merely as a custodian for their accounts, to investors who permitted the Ponzi debtor to manage their funds. Investors may seek to assert claims for both the amounts they invested with the Ponzi debtor and for their promised profits. Other types of general creditors of Ponzi schemes include trade creditors, such as utilities or landlords, and creditors who assert breach of contract claims for the failure of the Ponzi perpetrator to provide promised funding because the Ponzi scheme collapsed.

In determining how to administer the claims, a trustee or receiver is faced with two sets of issues. First, there is significant debate on how to value an investor's claim in a Ponzi scheme case. Investors seek allowance of expected profits based on their last account statement generated by the Ponzi debtor, while the trustee, receiver, and other government agencies seek to limit the amount of the claim to the amount invested less amounts distributed to them. [footnotes omitted]

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Kathy Bazoian Phelps is a partner at the law firm of Danning, Gill, Diamond & Kollitz, LLP, where she has been a member since her admission to the California Bar in 1991. She obtained her undergraduate degree from Pomona College in 1988, and her law degree from the University of California at Los Angeles in 1991. She represents trustees and receivers, debtors, secured and unsecured creditors, and creditors' committees in bankruptcy cases and has extensive litigation experience representing both plaintiffs and defendants in a wide variety of bankruptcy litigation matters. She frequently represents operating and liquidating trustees in cases pending in the United States Bankruptcy Court as well as receivers in the United States District Court and the Superior Court of the State of California. She is recognized by peers for her ability to trace and recover assets in large-scale complex cases and for her familiarity with all issues arising in Ponzi cases. She has developed a specialty in representing bankruptcy trustees and receivers in litigation involving fraudulent activities and has been lead counsel in large-scale litigation involving recovery of assets in Ponzi scheme cases. She has lectured widely and written on bankruptcy and receivership matters for the American Bankruptcy Institute, the National Association of Bankruptcy Trustees, the Association of Insolvency and Restructuring Accountants, the International Association for Asset Recovery, the American Bar Association, the National Association of Attorneys General, the California Bankruptcy Forum, the California Receivers Forum, and the Commercial Finance Corporation of California, in addition to other local organizations in Southern California. She is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes. See www.theponzibook.com.

Hon. Steven Rhodes has served as a United States Bankruptcy Judge in Detroit since 1985. He was chief judge of the court from 2002 to 2009. He has served two terms on the Bankruptcy Appellate Panel of the Sixth Circuit, and was chief judge of the Bankruptcy Appellate Panel from 2002 to 2004. Before his service as bankruptcy judge, he was a United States Magistrate in the Eastern District of Michigan from 1981 to 1985. Before that, he was in private practice (1977-1981) and served as an Assistant United States Attorney (1974-1977). His undergraduate degree is from Purdue University in Mechanical Engineering, and his law degree is from the University of Michigan Law School. In law school, he served as an editor of the Michigan Law Review. He was an adjunct professor at the University of Michigan Law School from 1992 to 2003, teaching bankruptcy law, and at the University of Detroit Law School in 1986, teaching ethics. In 1995, he was inducted as a Fellow of the American College of Bankruptcy. From 2005 to 2009, he was Vice President for Research of the American Bankruptcy Institute and on its Executive Committee, and the ABI awarded him its 2009 Distinguished Service Award. He is currently serving on the Board of Governors of the National Conference of Bankruptcy Judges and on the Judicial Council of Sixth Circuit. He has written widely on bankruptcy and has spoken at numerous conferences and seminars sponsored by, among other organizations, the Federal Judicial Center, the National Association of Bankruptcy Judges, the American Bankruptcy Institute, and the American Bar Association. He is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes. See www.theponzibook.com.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.