Dear Dave,
First of all, please take note, that the disclaimer at the bottom of
this page says: "Answers and comments provided on Google Answers are
general information, and are not intended to substitute for informed
professional [...] legal, [...] advice." In other words, if you're in
trouble (which I hope you're not, from your site you seem like a nice
guy), please contact a lawyer and don't be satisfied with online
advice.
Ponzi schemes are illegal sale of securities: the person on the top
receives funds (for which he offers the "investors" high returns);
pays some at the beginning; but leaves the rest with empty pockets.
(Also see:
<http://en.wikipedia.org/wiki/Ponzi_scheme>, also regarding the
difference between Ponzi and MLM or Pyramid schemes)
The Case of Innocent Investors
==============================
If the investor was an innocent part of a Ponzi scheme (that is, was
not aware that it is a scheme, a passive investor), he is himself a
victim. However, section 15 of the Securities Act 1933 reads:
"Every person who, by or through stock ownership, agency, or
otherwise, or who, pursuant to or in connection with an agreement or
understanding with one or more other persons by or through stock
ownership, agency, or otherwise, controls any person liable under
sections 11 or 12, shall also be liable jointly and severally with and
to the same extent as such controlled person to any person to whom
such controlled person is liable, unless the controlling person had no
knowledge of or reasonable ground to believe in the existence of the
facts by reason of which the liability of the controlled person is
alleged to exist."
http://www.sec.gov/divisions/corpfin/33act/sect15.htm
That is, if you willingly invest in a Ponzi scheme (or even if you are
an investor, whom the SEC has reason to believe would not fall for a
scam; someone who is supposed to realise that there is no such thing
as "make money quick" schemes), you are liable.
(Sections 11 and 12 could be found here:
Section 11 -- Civil Liabilities on Account of False Registration Statement
<http://www.sec.gov/divisions/corpfin/33act/sect11.htm>
Section 12 -- Civil Liabilities Arising in Connection with
Prospectuses and Communications
<http://www.sec.gov/divisions/corpfin/33act/sect12.htm>).
Profits Made from Ponzi Schemes
===============================
If you are innocent, eventhough you have been involved in a scam,
courts have already ruled that you could theoretically claim your
original investment back (naturally, as these are bankrupcy cases,
there are chances that you will never see it back). In Dicello v.
Jenkins (In re International Loan Network),160 B.R.1
(Bankr.D.D.C.1993), the court noted that investors in a fraudulent
operation or Ponzi scheme nonetheless have a claim for the return of
their initial investment". In other words, the court does not hold you
responsible.
Nevertheless, there is also the civil litigation issue of profiting
from a fraud, as part of Fraudulent Transfers acts. as noted in
Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995), cert. denied, 116
S.Ct. 673 (1995):
"It is no answer that some or for that matter all of [defendant's]
profit may have come from "legitimate" trades made by the
corporations. They were not legitimate. The money used for the trades
came from investors gulled by fraudulent representations. [Defendant]
was one of those investors, and it may seem "only fair" that he should
be entitled to the profits on trades made with his money. That would
be true as between him and [the principal or his corporations]. It is
not true as between him and either the creditors or the other
investors in the corporations. He should not be permitted to benefit
from a fraud at their expense merely because he was not himself to
blame for the fraud. All he is being asked to do is to return the net
profits of his investment - the difference between what he put in and
what he had at the end."
(ibid. 757-758.)
In the Scholes case, it has been decided that the innocent investor
could maintain profits that are in fact a return of the original
investment, but any profits would be handed to the debtors. The
Trustee in the original Ponzi case used fraudulent conveyance law only
to recover the profits of those who had unwittingly aided and abetted
the scheme (See Lowell v. Brown, 280 F. 193; D.
Mass. 1922). In this case, even those who have innocently invested
their money, not knowing that it is a Ponzi Scheme, will be held
responsible in the sense of losing their "profits".
Also see:
In re Raejean S. Bonham dba World Plus, Bankruptcy No. F95-00897
http://www.iciclesoftware.com/worldplus/WPBRAIssues/WPMSJPonziScheme.html
Scholes v. Lehmann
http://www.projectposner.org/case/1995/56F3d750/
This is, however, not the same in all states, and some rulings have
been in favour of innocent investors, see:
""Ponzi" investment had reasonable value; bankruptcy decision
affirmed", Daily Record (Rochester, NY), Jul 15, 2002 by Nora Jones,
<http://www.findarticles.com/p/articles/mi_qn4180/is_20020715/ai_n10067902>
Also see, in case of innocent investors:
When Innocent Investors Become Losers ? Litigating the Ponzi Scheme Case (PDF)
<http://www.shufirm.com/news/S0005274.pdf>
Promoting/Marketing a Ponzi Scheme
==================================
This is of course different when it comes to investors who were also
involved in promoting or marketing the scheme.
Section 12 of the Securities Act is relevant to your second question:
if you promote a scheme, you are liable:
"# In General. Any person who--
1. offers or sells a security in violation of section 5, or
2. offers or sells a security (whether or not exempted by the
provisions of section 3, other than paragraph (2) and (14) of
subsection (a) thereof), by the use of any means or instruments of
transportation or communication in interstate commerce or of the
mails, by means of a prospectus or oral communication, which includes
an untrue statement of a material fact or omits to state a material
fact necessary in order to make the statements, in the light of the
circumstances under which they were made, not misleading (the
purchaser not knowing of such untruth or omission), and who shall not
sustain the burden of proof that he did not know, and in the exercise
of reasonable care could not have known, of such untruth or omission,
shall be liable, subject to subsection (b), to the person purchasing
such security from him, who may sue either at law or in equity in any
court of competent jurisdiction, to recover the consideration paid for
such security with interest thereon, less the amount of any income
received thereon, upon the tender of such security, or for damages if
he no longer owns the security.
# Loss Causation. In an action described in subsection (a)(2), if the
person who offered or sold such security proves that any portion or
all of the amount recoverable under subsection (a)(2) represents other
than the depreciation in value of the subject security resulting from
such part of the prospectus or oral communication, with respect to
which the liability of that person is asserted, not being true or
omitting to state a material fact required to be stated therein or
necessary to make the statement not misleading, then such portion or
amount, as the case may be, shall not be recoverable. "
Also see Section 17 of the same law:
<http://www.sec.gov/divisions/corpfin/33act/sect17.htm>
Please note, that a promoter is liable even if they are themselves
victims (that is, haven't profited from the scheme, did not realise
when they got in that it was a scam).
In both cases, especially if there are no evidences that the person
involved knew that the investment plan was in fact a Ponzi Scheme, a
good lawyer might get the accused free of charge; but the fact is,
that knowingly promoting what seems like a Ponzi Scheme, or taking
part in it, is illegal.
Other Issues
============
There are other legal implications besides troubles with the SEC and
investment laws. Two relevant bodies here are the U.S. Post Office
(postal fraud laws, which would apply on someone promoting the scheme;
and might also apply for an investor who's promoting the scheme); and
the IRS (taxation of these alleged profits, if the investor is one of
the first ones). Reagdring the IRS, see i.a.
http://www.irs.gov/pub/irs-wd/0305028.pdf
Also see;
Chosnek v. Rolley
<http://www.in.gov/judiciary/opinions/archive/111903.ehf.html>
A bit entertaining take:
SEOmoz, To Ponzi or not to Ponzi, that is the question?
<http://www.seomoz.org/blogdetail.php?ID=939>
The Charles Ponzi site (An upcoming book by Mark Knutson)
<http://www.mark-knutson.com/>
Soneet R. Kapila, Chapter 7 Trustee, Plaintiff, v. WLN Family
Limited Partnership and Carlayne Holloway, Defendants, 341 B.R. 53 (2006)
http://www.wiwb.uscourts.gov/Decisions_tsu/In_re_LeNeve_U.pdf
Warfield v. Byron
<http://www.ca5.uscourts.gov/opinions/pub/04/04-10796-CV0.wpd.pdf>
I hope this answers your question. Please contact me if you need any
clarification on this answer before you rate it. |
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