Since the Bernie Madoff scandal grabbed headlines several years ago, investors have become more aware of what a Ponzi scheme is and how they operate. While the Madoff scandal was big news, most people still don’t realize that—at any given time in this country—there are thousands of Ponzi schemes being perpetrated against unsuspecting investors.
Once the scheme itself unravels, as they always do, investors are left asking themselves, “How can I get my money back?”
What Is a Ponzi Scheme?
A Ponzi scheme is a fraudulent investment operation that pays “returns” to investors from their own money, or money paid by later investors, rather than from an actual earned revenue. These schemes are illegal and operate on the “rob Peter to pay Paul” principle, where money from new investors is used to pay off the previous investors.
This continuous and destructive cycle eventually falls apart when not enough new investors can be found. In my experience, the strongest chance Ponzi scheme victims have to recover their losses is when the Ponzi schemer is associated with a registered brokerage firm.
Are Brokerage Firms Liable for Ponzi Schemes?
There are two theories under which a brokerage firm might be liable for its broker’s Ponzi scheme.
Duty to Supervise
The first theory of liability for brokerage firms is that, although the firm may claim to be unaware that one of its brokers is offering unlicensed and unlawful securities (known as “selling away”), brokerage firms have an absolute duty to supervise the actions of their brokers.
The brokerage firms can be held responsible for the losses sustained by victims of the fraud if the firm failed to adequately supervise its broker. Brokerage firms may not turn a blind eye while their representatives sell sham investments otherwise run rampant with its customers’ assets. They have an affirmative duty to implement and operate a robust supervisory system that adequately monitors and detects this type of misconduct.
This means that a brokerage firm can be forced to pay for the losses you suffered in a Ponzi scheme, even if the brokerage firm claims it was unaware of the broker’s misconduct.
Blue Sky Laws
The second theory is under a state’s securities laws. Every state has its own securities laws and rules often known as “blue sky laws.” While the laws certainly vary from state to state, all states require registration of securities offerings, brokerage firms, and brokers. All states try to prevent fraud. A traditional Ponzi scheme typically carries multiple state securities law violations, being that the whole system is a scam, and the securities being sold are not properly registered with the state.
The question then becomes which parties can be held liable under the state’s laws that the Ponzi scheme took place. For example, in Ohio, every person who has participated or aided the seller in any way making a sale that violates these acts are liable to the purchaser. Some states provide that if an entity receives any compensation for the fraud, whether directly or indirectly, that entity may be civilly liable.
It is hard to imagine a scenario where a schemer is able to conduct his illegal business without using one or more banks or financial institutions. A financial institution that accepts compensation, ignores red flags, and is essentially complicit in the scheme may be held liable under state securities laws for its aid to the schemer.
Suing a Ponzi Schemer
Many Ponzi scheme victims understandably want to file civil claims directly against the Ponzi schemer. From a practical standpoint, this approach often makes little sense. Once Ponzi schemers are discovered, it is usually the case that the schemer has spent all or most of the money. So while you could certainly sue the Ponzi schemer and very likely win a judgment against them in court, it’s unlikely you’ll recover any money at the end of the day.
In our experience, investors are much more likely to recover their losses by focusing their cases on the supervising brokerage firm and other third parties that may be held legally responsible for the Ponzi schemer’s misconduct and that have the financial ability to pay a judgment.
The Criminal Law Repercussions of Ponzi Schemes
When Ponzi schemes eventually collapse and the perpetrators are caught, there are usually separate criminal proceedings that are brought against the Ponzi schemer. There are often separate receivership actions, in which a court appoints a person called a “receiver” to gather the Ponzi schemer’s remaining assets.
Ultimately, whatever assets are collected are eventually distributed to creditors, including investor victims. The receivers typically establish a claims process requiring victims to prove their losses in a scheme. While these proceedings serve important purposes, they are generally not intended to make Ponzi scheme victims whole.
In our experience, Ponzi scheme victims get very little, if any, of their money back via criminal courts or court-appointed receivers. In most cases, while it does not hurt to file a claim with the receiver, it likely will not lead to a full recovery of your losses.
Steps to Take After a Ponzi Scheme
At the end of the day, if you’ve lost money as a result of a Ponzi scheme, there are a few steps you need to take:
- Do Not Contact Your Broker – Anything that you say to your broker may later be used against you and your potential recovery. Also, it is unlikely that you’ll get any useful information out of your broker. That is, assuming you can even reach him or her.
- Gather Relevant Records – Gather any paperwork, checks, correspondence, or other records you have relating to your investments or any returns from the scheme.
- Call a Securities Fraud Lawyer– You need to contact an experienced securities fraud lawyer. Because these claims are typically handled through arbitration rather than through a classic courtroom trial, the attorney handling your case needs to possess very specific knowledge and experience in order to obtain a successful outcome for you. These cases are generally very complex, confusing for lawyers and investors alike.
Are you the victim of securities fraud?
It is critical that you are prepared for the unique ins and outs of the FINRA arbitration process. David Meyer has provided an article for law students in the American Bar Association to help them understand the aftermath of a Ponzi scheme collapse. Contact a securities fraud lawyer at Meyer Wilson for a free case review!