Suits stemming from Ponzi
schemes have been on the rise. Victims of Ponzi schemes often face the prospect
of actions by trustees to recover distributions made during the life of the
scheme. This Emerging Issues Analysis examines the applicability of the safe
harbor defense of Bankruptcy Code section 546(e) to the schemer's victims.
Generally, the more legitimate the Ponzi scheme operator was, the more likely
the safe harbor will be available.
A review of recent case law
shows an incredible number of Ponzi scheme cases currently making their way
through the courts. It is unlikely that this rise in the number of Ponzi scheme
cases is due to the fact that there have been more fraudulent scams lately;
rather, it is because the deep recession of 2008 caused many of the schemes to
implode, thus bringing them to light.
Ponzi schemes can have horrible effects on the unsuspecting victims. The
victims often suffer devastating losses, which can even impact their ability to
live comfortably in retirement. Then, after the scheme unravels, the trustee oftentimes
causes more pain by bringing avoidance actions against the unsuspecting Ponzi
victims under chapter 5 of the Bankruptcy Code. The purpose of these suits is
usually an attempt to "true up" the amounts received back from the
scheme by the various victims, so that no one keeps more than the principal
amount they actually put into the scheme. See, e.g., In re Bernard L.
Madoff Inv. Sec. LLC, 654 F.3d 229 (2d Cir. 2011)(approving the use of the
"Net Investment Method") [an enhanced version of this opinion is available to lexis.com subscribers].
This commentary focuses on the safe harbor defense to avoidance actions
contained in Bankruptcy Code section 546(e). In general, the safe harbor of
section 546(e) was meant to protect the orderly functioning of the securities
markets by preventing avoidance of settlement payments made in connection with
securities. However, most courts today focus not on the original intent to
protect functioning public markets, but rather on whether the transaction meets
the tests of the specific statutory language. Because the way Ponzi schemes
operate can vary, the results of the various cases on the applicability of the
section 546(e) safe harbor often differ more because of the facts than because
of a disagreement as to how to interpret the applicable statutory sections.
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