This is obviously prompted by the Madoff fraud, so the applicable law for these questions would be that relevant to Madoff and to other notable Ponzi schemes, respectively.
Consider a pure Ponzi scheme like Madoff’s that did no real business at all but just paid early investors’ returns out of latecomers’ investments.
When the scheme has collapsed, the investors (not counting the people who actually ran the scheme) can be divided into three classes:
Class A: invested in bad faith (being aware that it’s a Ponzi scheme but counting on cashing in on time. Got out in time, got back their investment plus high returns. Class B: like Class A, but invested in good faith (were not aware, just lucky to get out in time). Got back their investment plus high returns. Class C: Did not get out in time, left holding the bag.
Would Class C investors have any luck suing the other two classes (or, alternatively, only Class A) to share the loss, arguing that their (Class A+B) returns were not paid out of profits from their own investments but out of Class C’s money?
Class A looks like a non sequitur–in what way did they invest in bad faith? They gave the guy money because he promised to give them their money back, plus more. They got their money back, plus more.
It could be challenging to reliably determine the state of mind of an investor. Did he sincerely believe that the abnormally high returns on his investment were valid, or did he at some level understand that he should just shut up, smile and cash the checks?
I would say that Madoff had a LOT of investors in Group “A”-these were sophisticated epople, who KNEW something wasn’t kosher. to quote one guy “we knew Madoff was cheating, we just din’t think he was cheating us”.
So, these people knew that madoff was running a scam. they got in on the action, and got out before the house of cards collapsed. In my mind, they were enablers to a crime.
The burden of proof sounds backwards here. If passively shadowing a scam is indeed illegal, shouldn’t they have to prove that you knew it, rather than you having to prove that you didn’t?
My understanding is that any investor who had profits could be called upon to return them to the pool. I was not aware the investor had to be aware the scheme was a ponzi. Does anyone have any cites to back up the assertion only those who knew it was a ponzi are the ones that can be called upon to cough up their ill-gotten gains?
No, because the goal in civil law is compensation, not retribution. In a Ponzi scheme, if you cashed out early, the money you received belonged to someone else, and it was effectively stolen from them. Who cares whether or not you knew it was stolen? It belongs to someone else, and you have it, so you have to give it back.
Compare the following situation. You are a limited partner in a partnership that owns a building. The general partner, without your knowledge, overinsures the building, then burns it down. The insurer pays out, and you get your 10% of the payout. The insurer later discovers the arson, and sues to get the payout back. Of course you should have to give your 10% back, even though you are innocent - the insurer never should have had to pay out the money in the first place.
So everyone who received any profits from the last six years loses those profits, and people in Group A not only lose those profits but also lose their principal (if they cashed out in the last 2 years). In addition, Group A doesn’t just include people who are aware that it was a scam, but includes people who even suspect or are advised that things may have been fishy.
No, you are right, and the article linked by Smitty, to the extent it says otherwise, is wrong.
The general rule is that “winners” in a Ponzi scheme, even if innocent, must disgorge their profits. This is another way in which the article is, at least impliedly, wrong - you need not disgorge your original investment. One case cite is Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008). There are several others from other jurisdictions holding the same way.
The legal theory is that the winners are beneficiaries of a “constructive fraud” - an unintentional fraud. They are entitled to a reasonable expectation of profits, but profits secured by the theft of the funds of later investors is not reasonable. Thus, the winners have no claim to the profits, and must pay them back.
Clearly everyone who was a part of the scheme (whether knowingly or otherwise) can’t get their principal back, right? Madoff made off with such an exorbitant sum that there’s not enough money left over to reimburse everyone their initial investiture, is there?
OK, I read the Bayou case. Interesting. It does say that the entire amount received from a Ponzi scheme - including principal - is subject to disgorgement. I’m not sure how this is going to end up. Bayou is a Bankruptcy Court decision. It has supporting precedential weight only, and it is in disagreement with a long line of cases. But there is logic behind the decision - though the opposing cases are logical as well.
“Beyond a reasonable doubt” and “innocent until proven guilty” are concepts that apply in criminal cases, not civil. The standard of proof in a civil case is “preponderance of the evidence”, which is a much looser standard. This is part of the reason why things happen like OJ Simpson being acquitted of murder but losing a wrongful-death lawsuit brought by Ron Goldman’s father.
By definition, if the money left over (including payouts recovered) is split evenly among the investors, no one can be made completely whole - the money the Madoff skimmed and spent (in excess of his net assets) is lost forever.
But it is important to note that the $30 or $50 billion figures cited as “losses” are not actually losses. Madoff didn’t skim off $30-50 billion and blow it at the track. Those figures are the amount required to make all current investors whole. But most of that money still exists, in the form of money previously paid out to investors and/or money Madoff skimmed and didn’t spend. At least some of that can be recovered to partially compensate victims.
The actual losses are going to be bad, but not $30-50 billion bad.
Yes, but absent the implied criminal liability. A better description is that is it money “had and received” - it can be completely innocent. If a bank robber drops $50,000 into an envelope and accidently puts a label with your address on it, you can be sued by the bank to recover the money, but you can’t be sent to jail for receiving it.
I heard a report that so far in the Bayou case they’ve recovered about $30 Million from prior investors, but that the legal fees expended in connection with recovering that money have totaled almost $20 Million. Good new for you Sua!
