Ponzi Schemes: A Recent Discovery?
Reviewed by Mathew Clingerman
Krys & Associates Cayman Ltd. Fellow, INSOL International Cayman Islands
Insol World, Second Quarter 2010
Chair: John Verrill, Dundas & Wilson LLP
Jeff Friedman, Kattern Muchin Rosenman LLP
Paul Winer, Weksmans Incorporating Jan S. de Villiers Leon Zwier, Arnold Bloch Leibler
Economic recessions not only increase the general level of corporate financial distress but can set the stage for “runs” on ponzi schemes, thereby exposing them for the frauds that they truly are. The recent global financial crisis has been no exception, with a number of large and high-profile ponzi schemes being uncovered.
A panel examined the characteristics of a ponzi scheme, and provided insights into the recent Tannenbaum and Madoff schemes and discussed claw- back recovery actions.
Mr. Zwier gave the audience a brief introduction to the basic characteristics and origins of ponzi schemes by examining the first such scheme committed by Charles Ponzi. Although Mr Ponzi hailed from a middle-class family, he used his personality and charisma to project an aristocratic background and made extravagant purchases to create an illusion of a successful business man.
Mr Ponzi created the safe sounding “Securities Exchange Company” and promised investors a fifty percent profit in 90 days. The scheme was marketed as a guaranteed arbitrage of postal coupons purchased abroad although in reality, the fundamentals and volumes did not support the reported profits and the principal had been siphoned away.
Mr Verrill leads the legal team advising the joint provisional liquidators of Madoff International Securities Limited (“MISL”) in the United Kingdom, and discussed issues that arose in coordinating the US and UK insolvency proceedings and in cooperating with the numerous government and regulatory authorities.
A trustee was appointed over Bernard L. Madoff Investment Securities, LLC in the US and joint liquidators were appointed over MISL in the UK. Government and regulatory agencies were involved from the outset and there was a huge demand for information. In the US, the Justice Department and FBI were involved while in the UK, the police, Financial Services Authority, the Serious Crimes Office, and the Serious Fraud Office were all wanting to investigate. The liquidators eventually consolidated their cooperation with the UK agencies through the Serious Fraud Office.
Special care was taken to obtain and preserve the evidence up to criminal standards and there were issues of privilege and self-incrimination to consider. The FBI and Serious Fraud Office were given priority to interview relevant individuals based on concerns that the liquidators’ and trustee’s powers to compel examination could taint the testimony thus obtained.
The liquidators and the trustee also needed to work out cooperation and coordination between themselves and their respective proceedings. They entered into cross-border insolvency and information sharing protocol agreements. An example of the cooperation in practice was the jointly conducted examinations by the trustee and liquidators.
Mr. Friedman turned to the issues of true and quasi ponzi schemes, and provided an outline of claw-back recovery actions in the US. Quasi ponzi schemes may have elements of legitimate business whereas true ponzi schemes have none and new investor money is simply used to pay-off earlier investors.
Preference claims are limited in that they can only seek to recover transfers made within a ninety day look-back periods (in the case of non-insiders) and only of principal as opposed to fictitious profits. While it is a necessary element in a preference claim that creditors receive more than they would otherwise under a liquidation scenario this is not usually difficult to establish.
Fraudulent transfer claims, on the other hand, may be able to recover both principal and fictitious profits and generally the look-back period is extended (in some cases up to 6 years from the transfer). The intent of the recipient is not relevant but a fraudulent intent on the part of the perpetrator is required. Good faith defences exist, but these however are not available to recipients who have knowledge of the fraud.