What is it with alleged Ponzi scheme perpetrators these
days? They seem to have a heightened sensitivity to the use of the words "Ponzi
scheme." In 2012, two cases were decided against two governmental agencies -
the SEC and the IRS-in connection with their use of the words "Ponzi scheme."
In a case brought by the SEC against Small Business
Capital Corp. and its principal, Mark Feathers, Feathers filed a Motion for
Restraining Order ("TRO"), Preliminary Injunction, Sanctions, and
Special Damages against the SEC, arguing that the SEC used "fighting words" in
certain publications related to the case. SEC
v. Small Business Capital Corp., 2012 U.S. Dist. LEXIS 178392 (N.D. Cal
2012). Feathers based his motion on the argument that the SEC's use of the
works "Ponzi-like" and "swindler" are "fighting words" which violated
that his First Amendment rights. The court, in denying Feathers' motion, noted:
The problem with Plaintiff's request in the context of
this action, however, is that claims under the First Amendment are not at issue
in this case. Indeed, the classic issue presented by "fighting words"
is whether such speech is constitutionally protected; in other words, whether
the challenged speech is "likely to produce a clear and present danger of
a serious substantive evil that rises far above public inconvenience,
annoyance, or unrest." City of Houston v. Hill, 482 U.S. 451, 462 (1987). Any party's
right to free speech is not implicated by the claims brought by Plaintiff,
which involves only violations of securities law. Absent such a free speech
issue, the court is unable to analyze whether Defendant could prevail on the
merits of a First Amendment claim.
The court found that "fighting words" lose
First Amendment protection only if they constitute "words that by their
very utterance inflict injury or tend to incite an immediate breach of the
peace." Id. at *5 (citing Hill, 482 U.S. at 461-62). After denying
Feathers' request for a TRO and preliminary injunction, the court cautioned:
With that said, however, the court expects all parties to
this case to act in a dignified and appropriate manner. The language utilized
in press releases, pleadings or other documents should be carefully chosen so
as not to denigrate others or unnecessarily jeopardize the viability of the
investment assets, especially when this case remains at the initial stages of
In a separate case brought against the IRS, Plaintiffs
Emerging Money Corporation, Emerging Administrative Services, LLC and Emerging
Actuarial Designs, LLC alleged that the IRS had wrongfully disclosed
information when it asserted to certain taxpayers that the transactions that the
"Plaintiffs had promoted to them were 'sham transactions' and part of a 'Ponzi
scheme.'" Emerging Money Corp. v. United
States, 873 F. Supp. 2d 451 (D. Conn. June 4, 2012).
The Plaintiffs' "claim was based on 26 U.S.C. § 7431,
which permits plaintiffs to recover damages when an officer of the United
States knowingly or negligently discloses returns or return information in
violation of Section 6103. Plaintiffs seek, inter alia, $1,000 for each
unauthorized disclosure of their return information." Id. at *6. The IRS filed a motion for summary judgment, arguing
that it was permitted to make those statements under the Internal Revenue Code.
The facts in the case were that the IRS had investigated
the Plaintiffs' "Stock to Cash" program in which a client would transfer shares
of stock to a lender and the lender would make an upfront cash payment called a
"loan." The IRS concluded that the program was a Ponzi scheme and delivered
letters to the clients who had participated in the program which included the following
information: "(1) identification of Plaintiffs as possible 'lenders' or
administrators of the Stock to Cash program (the 'identification of
Plaintiffs'); (2) the statement that the IRS was conducting an investigation of
the Stock to Cash program (the 'investigation assertion'); (3) the IRS's
position that the Stock to Cash transactions were 'sham transactions' (the
'sham-transaction assertion') and (4) the assertion that those transactions
were 'built into a Ponzi scheme' (the 'Ponzi-scheme assertion')." Id. at *4-5.
The IRS contended that it was entitled to disclose the
information under the "Own Information" exception under 26 U.S.C. § 6103(e)(7).
The court reviewed relevant case law and concluded that most of the information
disclosed was the recipients' own information because it "consisted of facts
that directly impacted the Recipients' tax liabilities." However, the court
noted, "But the Ponzi-scheme assertion did not directly impact the Recipients'
tax liabilities. Their 'loans' would have been considered sales of stock
whether or not the program was a Ponzi scheme. The fact that the transactions
were 'shams' was enough to establish to the Recipients that they were invalid,
without a contextual reference to a larger Ponzi scheme." Id. at *13.
The court reviewed several other exceptions, such as the
"Administrative Proceeding" Exception, the "Investigative Purposes" exception,
and the "Erroneous Information" issue, and ultimately concluded that the IRS
did not violate Section 6103 when it sent out the letters regarding most of the
information contained in the letters. However, the court found that the
"exceptions did not cover the IRS's assertion that the Stock to Cash program
was a Ponzi scheme." Id. at *23. The
court instructed the Plaintiffs to file a statement and explanation of the
damages they were seeking if they wanted to proceed to trial. The Plaintiffs
filed a supplemental statement asking for $69,000 in statutory damages, or in
the alternative, actual and punitive damages, plus attorneys' fees and costs.
The Plaintiffs' statement is attached here.
Two alleged Ponzi scheme perpetrators, two governmental
agencies, two courts, and two decisions - all involving the use of the words
"Ponzi scheme." If nothing else, these cases are a reminder that we are in this
country innocent until proven guilty, so we should tread carefully when using
those two little words.
subscribers can access enhanced versions of the opinions and annotated versions
of the statutes cited in this article:
SEC v. Small Business Capital Corp., 2012 U.S. Dist. LEXIS 178392 (N.D. Cal 2012)
City of Houston v. Hill, 482 U.S. 451 (1987)
Emerging Money Corp. v. United States, 873 F. Supp. 2d 451 (D. Conn. June 4, 2012)
26 U.S.C. § 6103(e)(7)
Read additional articles at The Ponzi Scheme
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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