Ponzi Schemes: Let the Investor Beware!

Palm Beach County Bar Association Bulletin, July/August 2008

In 1919 Charles Ponzi became one of the most notorious persons to develop an elaborate plan for swindling people out of money. In the “original” Ponzi Scheme, Charles Ponzi promised investors a 50% return on their money in 90 days. In the economic mess following World War I, Ponzi’s tale was to tell investors he would buy international postal coupons in foreign countries and sell them in other foreign countries at a 100% mark-up. Before long, Ponzi brought in millions of dollars in investments and in fact paid out significant returns on investments.

Unfortunately for the investors, this was a just a scheme and the international postal coupons were never actually purchased. This scheme, like other schemes which now carry the “Ponzi” name, was nothing more than a phony investment plan in which monies paid by later investors were used to pay artificially high returns to the initial investors, with the goal of attracting more investors. Ultimately, all Ponzi Schemes fail when the truth is discovered and/or the investors just dry up.

When a Ponzi Scheme fails, a bankruptcy often ensues and a bankruptcy trustee is entrusted with the responsibility of equalizing the financial pain of the creditors of the estate. One of the significant assets of the bankruptcy estate are claims against the “winners” in the Ponzi Scheme, i.e., those who received returns in excess of their initial investment.

Once the existence of a Ponzi Scheme operated by a debtor is established, payments received by the winning investors as purported profits, are deemed to be fraudulent transfers as a matter of law. In re Slatkin, — F.3d –, 2008 WL1946739 (9th Cir.). The “profits” are considered fraudulent transfers because the source of the “profits” was a theft from other investors, as none of the trades made by the debtor were legitimate. Id. Therefore, requiring investors to return the purported profits on their investments prevents the injustice that would result if they were allowed to retain these purported profits at the expense of other defrauded investors. Id.

The age old lesson of “if it sounds too good to be true, it probably is” is alive, well and applicable to get rich quick schemes similar to the one made famous by Charles Ponzi. In the case of a Ponzi Scheme which ends up in bankruptcy court, those who thought they were “winners” will ultimately end up having earned nothing more then a lesson on greed.