Ponzi schemes, named after the infamous swindler Charles Ponzi, have been around for more than a century. Yet, despite their age, these schemes show no sign of slowing down. In fact, headlines announcing the latest attempts to perpetrate these frauds still regularly fill the news cycle. And federal regulators keep the prosecution of Ponzi schemes at the top of their enforcement agendas.
In more recent years, investors and creditors have been harmed by names that have become well recognized, such as Allen Stanford of Stanford Financial Group, Tom Petters of Petters Group Worldwide, and Joel Steinger of Mutual Benefits Corporation. Whether you are a senior officer charged with making investment decisions or an individual investor, recognizing the hallmarks of a Ponzi scheme is critical to preventing involvement in these schemes and knowing what to expect in the aftermath of one. Unlike other kinds of investment fraud, true Ponzi schemes are largely illegitimate from the start, making it particularly challenging to recover lost funds.
A Ponzi scheme is a fraud where existing investors are paid with funds solicited from new investors. To perpetuate the scheme, there must be a regular flow of new investor money. A Ponzi scheme typically collapses when it becomes difficult to recruit new investors or when many existing investors seek to redeem their investments.
The U.S. Securities and Exchange Commission (SEC) has identified certain “red flags,” or common characteristics, of Ponzi schemes: high returns with little or no risk; overly consistent returns; unregistered investments; unlicensed sellers; secretive, complex strategies; issues with paperwork; and difficulty receiving payments.
While Ponzi scheme promoters may promise high returns with little or no risk, in most cases, the perpetrators of the scheme do not invest the money as promised. The scheme, therefore, yields little or no legitimate earnings, despite what may be represented to investors. This makes it particularly challenging to recover funds lost through investment in a Ponzi scheme. Investors who have the misfortune of losing money through their involvement may be worse off than investors who find themselves in the midst of other kinds of investment scams, making it all the more critical to spot and steer clear of these schemes from the start.
Alternatively, there may be investors who, by nature of the scheme, end up redeeming more money than they originally invested. In the aftermath of a Ponzi scheme, a trustee or a receiver is often brought in to help recover and return funds to harmed investors. Under fraudulent transfer law — whether federal law or New York’s more recently effective Uniform Voidable Transactions Act — one of the elements that oftentimes must be proven as part of the fraudulent transfer claim is actual intent to defraud. A presumption under the law, known as the Ponzi scheme presumption, has been developed and applied to establish this intent element.
As one court explained, “Courts have uniformly recognized a presumption of actual intent to defraud on the part of the transferor in the context of a Ponzi scheme.” Known as the Ponzi scheme presumption, an actual intent to defraud is presumed because the transfers made in the course of a Ponzi scheme could have been made for no purpose other than to hinder, delay or defraud creditors. This presumption helps the trustee or receiver establish the legal elements necessary to claw back money from those who may have innocently ended up with more in their pocket than they originally invested.
Although the “the remarkable criminal financial career of Charles Ponzi” — as described by the U.S. Supreme Court in Cunningham v. Brown — was more than a century ago, these schemes are still very prevalent. They leave significant investor losses and hardships in their wake. At the end of last year, the SEC issued an investor alert regarding investment scam complaints on the rise that specifically warned, “Watch Out for Ponzi Schemes.” Since then, the SEC has continued to pursue these fraudulent schemes, bringing charges, for example, against a Los Angeles-based individual and his company in connection with an alleged Ponzi scheme that raised over $690 million, and more recently a fraudulent mother-son offering involving a purported supercomputer and Ponzi-like payments to investors.
Finance executives responsible for making investment decisions on behalf of their employers or their clients must take special care to look out for the main red flags traditionally associated with Ponzi schemes: the promise of unrealistic or promised high returns; little or no risk; investment methodologies cloaked in secrecy or unusual complexity; no proof of assets; and lack of a reputable audit firm.
Being proactive from the start by asking questions and interviewing the entity’s lawyers and accountants will go a long way toward protecting investors and their assets from falling victim to a type of scheme that seems to be as popular today as it was a hundred years ago.
John J. Carney, a partner at BakerHostetler, is a former practicing CPA, SEC senior counsel, and federal prosecutor. He has served as an SEC receiver and bankruptcy examiner in major international Ponzi schemes and focuses on asset recovery matters. Bari R. Nadworny is an associate in BakerHostetler’s white-collar investigations and securities enforcement and litigation group and focuses her practice on regulatory enforcement and securities and governance litigation.