You Can't Cheat an Honest Man (36 page)

Despite internal discord, the various civil complaints were certified as a single class action suit in 1976—three years after the first suits had been filed.

In the criminal case, Trippet and Home-Stake executives Harry Fitzgerald and Frank Sims were charged in a 10-count indictment with defrauding investors of almost $100 million. In May 1976, they pleaded no contest to charges of mail fraud and conspiracy. The three men spent one night in jail and received probation. Trippet also paid a $19,000 fine and, as a result, was widely described as the “mastermind” behind “one of America’s greatest Ponzi schemes.” (Later in 1976, Norman Cross—who had been Home-Stake’s auditor—became the only person to go to trial on criminal fraud and conspiracy charges related to Home-Stake. He was acquitted.)

The civil lawsuits continued to churn along. During the early 1980s, more than $20 million in claims against Home-Stake were settled by insurance companies for several of the law firms that had advised Trippet and his colleagues.

According to William Wineberg, a San Francisco attorney who filed the original lawsuit in the case, collection efforts concentrated on the insurance companies that provided liability coverage for Home-Stake’s accounting firm, Cross & Co., and law firm, the defunct Kothe & Eagleton of Tulsa.

In February 1991, attorneys for three insurance companies asked the court to reconsider its ruling. The insurance companies—Continental Casualty Co., American Home Assurance Co. and Federal Insurance Co.—were liable for $56 million of the total $132 million judgment. And that number could increase to more than $74 million as post-judgment interest mounted during the appeals process.

The ruled that it “found no just reason for delay in entering the judgment.” So, the insurance lawyers appealed.

In 1994—six years after the initial class-action verdict—the U.S. Supreme Court ruled in another case that federal securities law does not permit a plaintiff in a civil lawsuit to make an aiding-and-abetting claim. The court concluded that this issue, common to Ponzi scheme lawsuits, was more appropriately addressed in criminal court.

The Home-Stake class-action case, which was a civil action, had made an aiding-and-abetting claim. The appellate court hearing the defendants’ appeal was bound by the Supreme Court’s new precedent. Accordingly, in January 1996, a the Tenth Circuit decided to send the case back—again—for re-trial.

Norman Cross’ longtime attorney, B. Hayden Crawford, who had been with the case since September 1973, said that “we feel the decision is correct and do not anticipate it will be changed.” He said he was “anxious for a re-trial” even after almost 23 years.

Likewise, the lawsuit has been a long road for wealthy investors who lost large amounts of money, another investor attorney said. “Many of the original investors are dead, so we are dealing with their children and grandchildren.”

This was part of the reason the parties were willing to settle. And they did so in 1996. According to lawyers familiar with the case, the amount of the settlement was close to the $56 million due from the three insurance companies.

Who Can Keep Ponzi Money?

Forget all the jokes you’ve heard about the definition of
chutzpah
. Few people are as brash as Ponzi perps...and those near or dear to them...determined to keep the money they’ve taken from trusting investors. Like case studies in a psychology textbook, these people will often convince themselves that the money is rightly theirs.

Luckily, the law—or at least the part of the law that deals with fraud— doesn’t put much stock in psychology. The 1995 federal appeals court case
Scholes v. Lehmann
dealt with some complicated issues of who can pursue whom in the wake of a collapsed Ponzi scheme. In the case, the receiver for several companies ruined by a Ponzi perp brought fraudulent conveyance actions against one of the investors, the perp’s former spouse and several religious organizations. All of these people or groups had received funds from the ruined companies.

The court of appeals ruled that the receiver had standing to assert the fraudulent conveyance claims. The people who’d received money from the scheme argued that the receiver was not really suing on behalf of the companies but on behalf of the investors who had invested in the corporations. They argued that a receiver cannnot sue on behalf of the creditors of the entity in receivership.

To sum up their argument, they asked the following question: How can allegedly fraudulent conveyances hurt the instrument—namely, the company—through which the Ponzi scheme was operated?

Judge Richard Posner provided the following answer:

The corporations, [the perp’s] robotic tools, were nevertheless ...separate legal entities with rights and duties. They received money from unsuspecting, if perhaps greedy and foolish, investors. That money should have been used for the stated purpose..., which was to trade commodities.... The three sets of transfers removed assets from the corporations for an unauthorized purpose and by doing so injured the corporations. Thus, it is the removal of assets that damaged the debtor, and the trustee has standing to sue for this type of injury.

So, the people who’d received money from the scheme could be forced to give it back.

In vivid language, Posner went on to explain: The appointment of the receiver removed the wrongdoer from the scene. The corporations were no longer the perp’s evil zombies. Freed from his spell they became entitled to the return of the money—for the benefit of the unsuspecting investors—that the perp had made the corporations divert for unauthorized purposes.

Civil RICO Claims

Because Ponzi schemes follow patterns of fraud and theft, many angry investors pursuing perps will try to press lawsuits which cite the Racketeer and Corrupt Organizations Act of 1970 (RICO). These can get very complicated.

A RICO claim must include seven constituent elements, namely:

1) that the defendant 2) through the commission of two or more acts 3) constituting a “pattern” 4) of “racketeering activity” 5) directly or indirectly...participates in 6) an “enterprise” 7) the activities of which affect interstate or foreign commerce.

One strength of a RICO claim is that it allows triple damages; one problem is that it can be tough to make. When investors allege predicate acts of fraud as the basis of their RICO complaint (which is always so in Ponzi scheme cases), they must plead injury and causation with particularity. This means the person making the claim has to show a direct causal link between his injury and specific acts of mail or wire fraud. To state a claim of mail fraud or wire fraud, a complaint must allege:

1) a scheme or artifice to defraud or to obtain money by means of false pretenses, representations, or promises;

2) use of the mail for the purpose of executing the scheme; and

3) a specific intent to defraud either by devising, participating in, or abetting the scheme.
And then, these charges have to be linked back to specific losses suffered by the people making the RICO claim.

Another difficulty in making a civil RICO claim is that the person doing so has to have exhausted other avenues of recouping lost investments. A federal court in New York put this point plainly:

a plaintiff who claims that a debt is uncollectible because of the defendant’s conduct can only pursue the RICO treble damages remedy after his contractual rights to payment have been frustrated....Until plaintiffs can demonstrate that the orthodox methods of recovery have failed them, and that defendants’ acts of racketeering have in fact caused them a loss, they should not be entitled to treble damages under RICO.

Finally, a loss claimed in a civil RICO suit can’t be speculative in nature. It must be definable on a factual basis—even if only approximately definable.

Burned Investors vs. Angry Creditors

When burned investors try to get their money back from other investors who got their money out, some pretty arcane parts of the law come into play. Chief among these: Passage of title.

In legal terms, a
sale
is defined as the “passing of title from the seller to the buyer for a price.” The passing of title to goods cannot occur before goods are identified in a contract. After this identification, title can pass in any manner and on any conditions explicitly agreed upon by the buying and selling parties. During the interval between the time the goods are identified in the contract and title passes, the buyer has a “special property” in the goods.

In the absence of explicit agreement, title passes to the buyer when and where “the seller completes his performance with reference to the physical delivery of the goods.” When people were talking about bolts of fabric or barrels of rum, these distinctions were easy enough to understand and apply. When people are talking about investments in securities, things can get a little fuzzy.
The relationship between a creditor and the Ponzi scheme company is usually pretty clear. The relationship between an investor or distributor and the company is more problematic—and determined in many cases by how title to goods has passed. In short, this issue deals with who owned the investment capital, who owned the assets of the enterprise and when did these items exchange hands.

This distinction often comes into play when commercial creditors of a Ponzi scheme company are battling with investors for who should come first in the resolution. It’s especially important when the Ponzi scheme involves multiple levels of salespeople or distributors. The result can be a complicated hash of people trying to take whatever money or goods are left when the scheme collapses.

One often-used tool for clearing up the complication is the so-called “dominion” or “control” test. This standard requires “dominion over the money or other asset, the right to put the money [or asset] to one’s own purposes” such as to “invest in lottery tickets or uranium stocks.” On this issue, one court has written:

Logic and equity require that ordinary market-price sales by retail merchants acting in good faith not be contorted beyond commercial practice for the purpose of expanding the merchant’s status as a captive risk taker.

So long as a merchant has no reason to suspect a customer’s Ponzi scheme or other skullduggery, sales made under ordinary commercial terms will usually be viewed as legitimate transactions between merchant and customer. Simply because they claim they are “owed money too,” burned investors can’t nullify the honest debts of dishonest companies.

Fraudulent Transfers

In the wake of a collapsed Ponzi scheme, people will rush to claim “fraudulent transfer” in the hope of getting some of their money back. However, the circumstances that support a fraudulent transfer are more limited than most people think. A major source of misunderstanding is that the word “fraudulent” has such pejorative connotations that it becomes difficult for most people to think dispassionately about it. According to federal law, fraudulent transfers are subdivided into
actually fraudulent transfers
and
constructively fraudulent transfers
. The key distinction between these two types is the intent of the transferors. Intent is essential to actually fraudulent transfers; it’s immaterial to constructively fraudulent transfers.

Bankruptcy law, which controls many of the elements of fraudulent transfer, states that a court or court-appointed trustee may:

avoid any transfer of an interest of the [bankrupt Ponzi company] that was made or incurred on or within one year before the date of the [scheme’s collapse.]

This goes for deals with creditors as well as deals with other investors. However, in order to nullify the transfer, the court has to show that the perp did one of three things:

1) made the transfer or incurred the obligation with intent to hinder, delay, or defraud any entity to which the company was or became indebted;

2) received less than a reasonably equivalent value in exchange for such transfer or obligation; or

3) became insolvent or intended to incur debts that would be beyond its ability to pay as a result of the deal.

(The first activity constitutes an actually fraudulent transfer; either the second or third constitute constructively fraudulent transfer.)

These activities are relatively difficult to prove in connection with an honest corporate debt. So, as noted previously, courts don’t often nullify deals with creditors.

On the other hand, the three standards—particularly the first and third—do fit many of scenarios offered to Ponzi investors.So, courts more often use the fraudulent transfer theory to force investors who took money out of a Ponzi scheme in its last year to give it back.

There are other legal complications. A court can find a transfer fraudulent but choose not to nullify it. And, even if a court
does
nullify a transfer, it can choose not to force any judgment against the transferees. The fraudulent transfer statutes provide carefully crafted remedies and limitations on remedies.

Not every transferee is liable; for example, subsequent good faith transferees often have no liability.

Many courts dealing with these issues cite the 1985 federal court decision
Johnson v. Studholme
as a standard of basic fairness. In the wake of a failed Ponzi scheme, the receiver for the defunct Ponzi entities filed lawsuits against all those investors who had received amounts in excess of their contributions.

The
Johnson
court ruled that the investors had given value for the profits they’d received and, thus, had not received fraudulent conveyances. The court held that the capital contributions made by the investors and the risk that they could lose all or part of their investments had been their contribution.

“Unjust Enrichment” and Other Notions of Fairness

Many state have laws which prohibit “unjust enrichment”—or some similar activity. For example: To prevail on a cause of action in Illinois based on a theory of unjust enrichment, a burned investor must prove that the Ponzi perp has unjustly retained a benefit to the investor’s detriment—and that the perp’s retention of the benefit violates the principles of justice, equity, and good conscience.