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.
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.
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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