Ponzi Scheme Victims: Are Courts Looking Under Rocks for Reasons to Bar Recovery?

Ponzi Scheme Victims: Are Courts Looking Under Rocks for Reasons to Bar Recovery?

 Ponzi Scheme Victims: Are Courts Looking Under Rocks for Reasons to Bar Recovery?  

What is the defrauded investor to do? Defrauded out of their retirement savings, home equity, and lines of credit, investors often only have litigation claims against third parties to redress their losses. Most people – except usually the Ponzi schemer – feel sorry for the victims. Yet our judicial system seems to continually find ways to block recovery for victims, dismissing their claims before they can even get their case in front of a jury.

The recent flurry of legal decisions coming out of Ponzi scheme cases have all too frequently barred defrauded victims any legal redress in court, either directly or through a court-appointed fiduciary such as a bankruptcy trustee or federal equity receiver. Some of the more common roadblocks are:

Roadblocks for Investors

  • Investors don’t have standing to bring claims.
  • While investors may be entitled to their net losses, they are not entitled to expected profits.
  • Investors cannot bring class actions pursuant to Securities Litigation Uniform Standards Act of 1998, 15 U.S.C. § 78bb ("SLUSA") [an annotated version of this statute is available to lexis.com subscribers].
  • Heightened pleading standards for class actions pursuant to Private Securities Litigation Reform Act, 15 U.S.C. § 77a, et seq. ("the PSLRA") [annotated version].
  • Investors get sued to give back monies they were paid during the scheme on fraudulent transfer theories.

Roadblocks for Trustees and Receivers

            Quite often, the Ponzi schemer ends up in bankruptcy or a receivership, and a trustee or receiver is appointed to administer the assets for the benefit of the defrauded investors. This should be good news for the investor, right? Now a fiduciary is charged with the task of locating the assets and filing the lawsuits to recover money for the benefit of the victims. But trustees and receivers encounter their own barriers to recovery, denying them the ability to recover funds for the benefit of the victims. The more common roadblocks encountered by trustees and receivers are:

  • They don’t have standing to bring claims.
  • Since they stand in the shoes of the wrongdoers, they are barred by the in pari delicto doctrine from bringing third party claims.
  • They are barred from pursuing certain fraudulent transfer claims under the settlement payment defense in 11 U.S.C. § 546(e) [annotated version].

A New Roadblock to Recovery?

A recent decision in the Madoff case highlights a few other less obvious problems that trustees and receivers face in recovering money for victims. SIPC v. Bernard L. Madoff Investment Securities, LLC, 2013 U.S. Dist. LEXIS 172638 (S.D. N.Y. Dec. 5, 2013) [an enhanced version of this opinion is available to lexis.com subscribers].

  • Standing by Assignment

As a way around the standing problem, fiduciaries often try to obtain assignments of investors’ claims so that they can acquire standing and take claims that are free of the in pari delicto taint. Whether standing may be acquired through assignment of claims depends in part on state law and in part on the terms of assignment.

The court in the Madoff case held that the SIPA Trustee did in fact acquire standing from the assignments that he had obtained from the customers of Madoff to bring claims against certain feeder funds for aiding and abetting fraud and unjust enrichment. 2013 U.S. Dist. LEXIS 172638. The court said, “the Second Circuit has held, in the context of a non-SIPA  bankruptcy, that ‘a trustee may assert claims assigned to it by a bankrupt's creditors for the benefit of the estate, because those claims can become property of the estate under § 541(a)(7).’" Id. (citing In re CBI Holding Co., Inc., 529 F.3d 432, 459 (2d Cir. 2008) [enhanced version]. In finding that the Madoff trustee had standing to bring validly assigned common law claims, the court concluded that, “where nothing in § 78fff-2(b) explicitly restricts the Trustee's authority to obtain assignments under the Bankruptcy Code, and where such an assignment raises none of the concerns addressed in JPMorgan II, the Trustee has standing as an assignee of creditor claims to assert those creditors' common law causes of action against third-party defendants.”

This alone would have been a great victory for defrauded customers. However, what the court gave in one hand, it took back with the other.

  • Assignments Created a SLUSA Barrier

The court then considered the second question of “whether the Trustee’s pursuit of those claims is precluded by SLUSA.”

SLUSA provides that "[n]o covered class action based upon the statutory or common law of any State . . . may be maintained in any State or Federal court by any private party alleging[] a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security." 15 U.S.C. § 78bb(f)(1)(A).

A covered class action” is "any single lawsuit in which . . . damages are sought on behalf of more than 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, without reference to issues of individualized reliance on an alleged misstatement or omission, predominate over any questions affecting only individual persons or members." 15 U.S.C. § 78bb(f)(5)(B)(i).

However, SLUSA also includes a "counting" provision, under which "a corporation, investment company, pension plan, partnership, or other entity, shall be treated as one person or prospective class member, but only if the entity is not established for the purpose of participating in the action." 15 U.S.C. § 78bb(f)(5)(D).

The court in Madoff considered whether the Trustee's aggregation of claims through assignment constitutes a "covered class action" under SLUSA. The court found that it does and that the Trustee was, therefore, barred from bringing the claims. The court reasoned:

Courts generally have held that bankruptcy trustees should be treated as a single entity under SLUSA in order to avoid undermining a trustee's ability under the Bankruptcy Code to pursue claims owned by the debtor. See LaSala v. Bordier et Cie, 519 F.3d 121, 136 (3d Cir. 2008) ("Giving effect to Congress's desire not to preempt claims that pass from a debtor corporation to its bankruptcy estate is important because to do otherwise would work a significant change in the bankruptcy system that Congress created and, according to the legislative history cited above, intended to leave undisturbed.") [enhanced version]. Here, however, the Trustee is not attempting to pursue claims belonging to the debtor, a single entity, for the benefit of many; rather, he seeks to assert claims belonging to many creditors as a single entity. Thus, the Court must look through the Trustee's form to the source of the Trustee's claims in order to properly apply SLUSA on the facts of this case.

This case is a reminder to trustees, receivers and investors that, when planning a strategy to avoid standing and in pari delicto issues, they should keep in mind that the solution to one problem might create another. Regardless, given all these roadblocks, the economic outcome for investors is that investors are all too frequently barred from pursuing their direct claims against third parties. Also, they cannot rely on a bankruptcy trustee or equity receiver to succeed in bringing either the debtor’s claims or assigned claims. It seems to be an increasingly steep climb for investors.

To avoid investing in a Ponzi scheme in the first place, read about my new book Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams at www.ponzi-proof.com.

Read additional articles at The Ponzi Scheme Blog

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

Kathy is also the author of is Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams. For more information, or to purchase the book, click here.

Watch Kathy’s interview on The Not So Legal Show.

For more information about LexisNexis products and solutions connect with us through our corporate site.