It sounds like a good idea: Insure against losses from investing
in a Ponzi scheme. Insurance policies, including homeowner's policies, can
provide coverage from losses from fraud, embezzlement or forgery. But does it
work to provide compensation for losses in a Ponzi scheme?
Last year, the Second Circuit affirmed a district court's
dismissal of a Madoff customer's complaint against a homeowners policy, but not
for the reasons you might expect. Horowitz
v. American International Group, Inc., 498 Fed. App'x 51 (2d Cir. 2012) [an enhanced version of this opinion is available to lexis.com
Horowitz purchased a homeowner's insurance policy from
AIG with a Fraud Safeguard endorsement providing for up to $30,000 in coverage
for losses resulting from fraud, embezzlement or forgery. Horowitz had invested
a total of $4,327,230.55 with Madoff and had withdrawn $4,553,000, leaving a
balance that Horowitz believed to be more than $8.5 million of expected profits.
AIG denied coverage, finding that Horowitz had not
suffered a loss under the policy terms. After Horowitz sued AIG, the district
court dismissed the complaint, finding that the Madoff Ponzi scheme was not a
peril covered by the policy and that a Ponzi scheme is not a predictable peril.
The Second Circuit disagreed, finding that "a Ponzi scheme is likely just the
sort of fraud anticipated by the policy drafters." Id. at 53.
That should mean a win and $30,000 of insurance benefits
for Horowitz, right? Not in that case. Even though Ponzi scheme losses were
covered, the Second Circuit found that, "in our view the dispute in this case
turns not on whether the peril, i.e., the Madoff fraud, is a covered event, but
on the Horowitzes' remaining arguments concerning which losses flowing from
that fraud are directly attributable to the covered conduct and thus
recoverable under the policy." Id.
The Second Circuit rejected Horowitz' interpretation of
"loss" and found that "the covered loss is limited only to the 'something' of
value' that the Horowitzes were induced to part with as a result of the fraud."
In other words, their expected profits of over $8.5 million were not "something
of value" and therefore not a covered loss.
The decision is in line with decisions on other issues in
Ponzi scheme cases ranging from fraudulent transfer claims to claims
distribution that draw a distinction between an investor's capital investment
and expected profits. The Second Circuit expressly rejected Horowitz's alternative
methodologies of loss calculations:
(1) the full account balance as reflected in their final
(2) earnings reasonably expected on their capital
investment based on a growth assumption or implied interest rate;
(3) net loss in constant dollars;
(4) non-recoverable tax payments; or
(5) legitimate growth on investments during the pre-Ponzi
The lesson here is that while an investor can obtain
insurance in the hope of recouping some of the losses in a Ponzi scheme, to
recover, the investor must prove an actual loss of value and not merely a loss
of expected profits.
For other decisions relating to Madoff investors' claims
against their insurance policies, see Lissauer
v. Fireman's Fund Insurance Companies, 459 Fed. App'x 67 (2d Cir. 2012) [enhanced version]; Chaitman v. Chubb Insurance Co. of New Jersey, 2012 N.J. Super.
Unpub. LEXIS 2738 (Sup. Ct., App. Div. Dec. 14, 2012) [enhanced version].
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.
Watch Kathy's interview on the The Not So Legal Show.
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