Should a state provide
funding to reimburse victims of Ponzi schemes? Is it possible for states to
promulgate fair and comprehensive laws in this regard? Does funding at the
state level to reimburse victims give those victims a disincentive from
exercising caution and avoiding the frauds in the first place? These are difficult
questions that a few states have already decided and others may join. Laws are
on the books in Indiana and Montana, and New Hampshire is thinking about it.
In 2010, Indiana became the first state to adopt legislation establishing a
"Securities Restitution Fund." The law gave the Indiana Securities
Commissioner the ability to award victims a portion of their losses up to
$15,000, or 25% of unrecovered awards, whichever is less. Eligible victims are
required to show proof that restitution was awarded by a court or
administrative agency. The fund was established with an initial $2 million from
Securities Division fines paid by violators of the Indiana Securities Act. The
Fund continues to be derived from the Enforcement Fund, which is funded by
fines and does not depend on any tax dollars. The Indiana legislation is here. For more information about the Indiana Securities
Restitution Fund and to apply for restitution from it, click here. Frequently asked questions are here.
Pros and Cons of Indiana
Good Faith Considerations: The law contemplates consideration of
"whether a victim contributed to the infliction of the victim's monetary
injury." Additionally, no restitution assistance shall be awarded if the
victim participated or what happens if a victim were overly greedy or willfully
blind to the fraud when deciding to invest, or how that kind of determination
should be made. The issue of good faith is often an extremely costly and hotly
contested issue when the issue arises in litigation in Ponzi scheme cases.
Double Recovery Considerations: The law also contemplates a right of
subrogation for the state, which presumably would solve the problem of a
potential double recovery by the victim. On the other hand, the law provides
that the state could commence its own action or intervene in an action brought
by the victim, but it is hard to imagine the state pursuing this course of
action, particularly where the amount at issue is capped at $15,000.
Scope of the Class of Victims Covered: It is noteworthy that this
Restitution Fund only applies to victims of securities violations. Victims of
other types of Ponzi schemes - of which there is an infinite variety -
therefore appear out of luck. A Ponzi scheme can involve just about any
business model, not just securities. One must question why securities Ponzi
scheme victims are afforded special treatment under this law.
Impact of the Fund: And then there is the over-arching question of
whether any of this matters because it is unclear how often the Fund will be
used. On August 23, 2012, Indiana authorities announced in a press release,
available here, that the first payment from the Securities Restitution Fund, in
the amount of $15,000, would be made to Steve Brodie. Brodie lost his life
savings of $400,000 to Keenan Hauke, who was the manager of a hedge fund called
Samex Capital Partners, LLC, and who bilked over 30 investors out of $7 million
to $10 million. Hauke pled guilty to federal securities fraud charges and was
sentenced to over 10 years. Although $15,000 makes just a small dent in the
total damage, at least it's something.
In 2011, Montana established the "Securities Restitution Assistance
Fund," to be financed by court-ordered contributions from white collar
criminals and those who voluntarily contribute to the fund. The relief to be
provided is phrased as follows: "There is an account in the state special
revenue fund to the credit of the commissioner for use only for securities
restitution assistance. . . The fund may be used by the commissioner only to
pay awards of restitution assistance under this part." The purpose is
stated to be "to provide restitution assistance to victims who: (1) were
awarded restitution in a final order issued by the commissioner or were awarded
restitution in the final order in a legal action initiated by the commissioner;
and (2) have not received the full amount of restitution ordered before the
application for restitution assistance is due." Victims can receive the
lesser of 25% of their losses or $25,000, and only if "the person ordered
to pay restitution has not paid the full amount of restitution owed to the
Recently, the Montana law was enhanced. On March 7, 2013, Montana Governor
Steve Bullock signed House Bill 81 into law, making public funds available for
the Securities Restitution Assistance Fund. It authorizes the deposit of a
percentage of securities registration, filing or renewal fees into the Fund.
The original 2011 law is here. Montana House Bill 81 is here. For more information
about the Montana Restitution Assistance Fund and to apply for restitution from
it, click here. The regulations of the Montana Securities Department
relating to the fund are here.
The first payment from this fund, in the amount of $13,750, was made in July
2012 to Reece Cobeen, who had invested $55,000 in phony promissory notes sold
by Terry Parks, purportedly to help rebuild homes in Louisiana after Hurricane
Katrina. Parks promised Cobeen a 24% annual return on the investment. Parks was
convicted on three counts of investment fraud and was sentenced to 10 years
Pros and Cons of Montana
Good Faith Considerations: This law appears to leave no room for
consideration that a victim applying for relief may have unclean hands. It
certainly could not be the intent to compensate those that are in cahoots with
the violator, but what about those victims who were overly greedy and chose not
to vet the investment program into which they were pouring their money? And,
worse yet, what if laws like this provide some assurance to would-be victims
that the state will have their back if something goes wrong, leaving an
investor emboldened to gamble on a high-risk high-reward investment without
conducting proper due diligence? While this most certainly cannot be the intent
or objective of the law, more detailed guidelines prohibiting payments to those
not in good faith could go a long way in removing the disincentive to conduct
due diligence that this law arguably creates.
Double Recovery Considerations: The law also does not appear to have
contemplated the possibility that victims may have received recoveries from
other sources, such as payment in connection with a claim filed in a bankruptcy
case, or a restitution or restoration payment made by the federal government in
connection with a related forfeiture proceeding.
Scope of the Class of Victims Covered: Like Indiana, Montana has limited
this source of recovery to victims of securities violations only. One only
needs to glance at the newspaper to see the wide variety of non-securities
frauds that this excludes.
Will New Hampshire join Indiana and Montana in providing relief to fraud
New Hampshire Senate Bill 180 is entitled, "Establishing a recovery fund
for victims of the Financial Resources Mortgage (FRM) fraud, continually
appropriating a special fund and making an appropriation therefor." At
present it has been favorably reported out of a Senate committee and is
awaiting final action. The New Hampshire fund would deal with victims of just
one fraudulent scheme - Financial Resources Mortgage. It would establish the
"FRM Recovery Fund," to provide "recovery assistance" to
victims of the FRM fraud. The text of the required application form is set
forth in the bill. The Fund will be financed with $3 million per year in tax money.
New Hampshire Senate Bill 180 is here.
FRM and its principals, Scott Farah and Donald Dodge, defrauded 250 investors
out of about $33 million. Farah was sentenced to 15 years in prison. Dodge was
sentenced to 6½ years.
Pros and Cons of New
Hampshire FRM Restitution Fund
Scope of the Class of Victims Covered: The New Hampshire bill is far
narrower than the already narrow restitution fund laws in Indiana and Montana,
which are limited to securities fraud. This bill appears to appropriate tax
dollars to pay victims of one particular fraudulent scheme - the FRM scheme
only. One would think that tax-paying victims of different fraudulent schemes
would find this quite objectionable.
Double Recovery Considerations: The bill requires an application process
that takes into consideration mortgages retained and distributions received
from the bankruptcy case or other sources.
Good Faith Considerations: The bill also contemplates that recovery
shall be prohibited if it is determined that the claimant engaged in fraud or
related wrongful conduct or the claimant profited from the scheme.
The Controversy: Victim
Assistance vs. "Moral Hazard"
Proponents of these types of state restitution funds have good intentions -
let's get money back to the victims. According to a press release issued when
the Indiana law was enacted, the Indiana Secretary of State argued that the law
will "protect investors from financial attacks," and "directly
help victims avoid fraudsters and recover more of their losses when they do
become victims of financial crimes." That press release is here.
Opponents, however, argue that the state has no responsibility to compensate
the victims of financial fraud, even if state agencies were negligent, and that
"Doing so would also create a 'moral hazard,' an increased willingness to
make risky bets that betters can lose and taxpayers can't win." See
"Editorial: Lawmakers should reject fund for FRM victims", Concord
Monitor in New Hampshire, March 20, 2012. The editorial cites The Ponzi Scheme
Blog for our listing of the many Ponzi scams that have been exposed. The Concord
Monitor editorial is here.
What do you think? Should the states assist fraud victims or does it create a
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 the ABI Journal and 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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