High profile schemes perpetrated by Bernie Madoff, Allen Stanford, Nevin Shapiro, and others have brought, or at least reinforced, a general understanding of the term "Ponzi scheme" into the public lexicon. But what, legally, is a Ponzi scheme? In SEC v. Management Solutions, Inc., 2013 WL 4501088 (D. Utah Aug. 22, 2013), Judge Bruce Jenkins endeavored to answer that question and, in the process, authored an encyclopedic account of the term and key court opinions, from seven federal circuits, that have construed it.
Management Solutions was an SEC enforcement action against a father-and-son team that had allegedly raised over $200 million through a "classic Ponzi scheme." According to the SEC's complaint, investors in the scheme were sold "membership interests" in an apartment-flipping business and were guaranteed a return of five to eight percent. In reality, the funds were allegedly deposited into a general account and were used to pay a variety of expenses, including returns to other investors. Each of the defendants in the SEC case settled without admitting or denying the allegations.
A hearing was held in 2013 to determine whether, as argued by the court-appointed receiver, the scheme was properly classified as a "Ponzi scheme" and, if so, at what point that designation became applicable. The receiver sought such a finding in order to obtain the so-called "Ponzi presumption," which is sufficient to establish actual intent to defraud.
The court began its analysis by noting that "there is no absolute list of required elements for a Ponzi scheme" and proceeded to examine the history of the term dating back to Charles Ponzi's 1919 scheme of promising his investors that their funds were used to purchase postal coupons that he would, he promised, sell for twice the price. After beginning with Ponzi, Judge Jenkins' opinion walked through each of the key cases that have followed, including decisions from numerous federal circuits that dealt with schemes promising investments in, among others, the fox breeding business, oil wells, and a beverage bottling company.
Judge Jenkins found that the "common base" in the definition of the term used amongst federal courts is that "returns to investors are not financed through the success of the underlying business venture, but are taken from principal sums of newly attracted investments." He added that a keystone of schemes perpetrated by Ponzi, Madoff, and others is the existence of an "assetless shell."
The scheme in Management Solutions was, on the contrary, "far more complex" and displayed "characteristics of commercial schizophrenia." Some of the loans and property sales that were tangled up in the scheme "appeared to be regular" while others patently were not. The benefit of the "Ponzi presumption" would not, therefore, be applied to the entirety of the enterprise from either a temporal or a structural standpoint. Instead, the court held, each individual transaction, including the knowledge of the relevant parties, "needs to be examined on an individual basis." Thus, Judge Jenkins' analysis culminated in the conclusion that the "Ponzi presumption" should be reserved for those cases that deal with schemes that are "assetless and fraudulent from day one" and should not be applied to other securities fraud cases that have "some Ponzi characteristics."
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