The United States Supreme Court to Decide Whether Victims of Ponzi Schemes Can Bring State-Law Class Actions Against Defendants Who Aid and Abet Fraud

            An important decision on the ability of Ponzi scheme victims to use class action lawsuits to recoup their losses is expected from the U.S. Supreme Court.  At the opening of the current term, the Court heard oral argument in the case Proskauer Rose, LLP v. Troice, a consolidated appeal of a decision by the U.S. Court of Appeals for the Fifth Circuit involving claims by victims of the infamous multi-billion dollar Ponzi scheme perpetrated by Allen Stanford. 

In the Proskauer cases, the plaintiffs filed class action lawsuits in Louisiana state court against various defendants, including brokerage firms, insurance companies and law firms, for their alleged role in Stanford’s massive Ponzi scheme.  At the heart of his fraud, Stanford arranged for affiliates to sell certificates of deposit issued by the Stanford International Bank that were represented to pay above-market returns and which were falsely characterized as being backed by safe, liquid investments.  According to an earlier lawsuit filed by the SEC against Stanford, “[f]or almost 15 years, SIB represented that it consistently earned high returns on its investment of CD sales proceeds. . .In fact, however, SIB had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs, because it did not have sufficient assets, reserves and investments to cover its liabilities.” 

The investors’ lawsuits against the defendants alleged that, by their actions, the brokerage firm, insurers and law firms aided and abetting Stanford’s Ponzi scheme and misrepresented the validity of the CDs.  The lawsuits were filed in state court and alleged state-based claims, and the defendants removed the cases to U.S. District Court on the basis of the Securities Litigation Uniform Standards Act (“SLUSA”). 

            SLUSA was enacted in the wake of the Private Securities Litigation Reform Act (“PSLRA”), which Congress passed in response to the purported “rampant nuisance filings [of securities litigation], targeting deep-pocket defendants [and] vexatious discovery requests.”  The PSLRA restricted recoverable damages and attorneys’ fees and, importantly, imposed strict pleading requirements on class action securities lawsuits.  In order to avoid the PSLRA’s challenges, plaintiffs began filing securities class action lawsuits in state courts, alleging only state-based causes of action.  Congress responded to these efforts “to frustrate the objectives of the PSLRA” by enacting SLUSA, which provides for removal and dismissal of a state-based class action lawsuit that alleges a misrepresentation or omission of material fact “in connection with” the purchase or sale of a covered security. 

            At issue before the Supreme Court in Proskauer is the proper test to be used to determine the “in connection with” requirement of SLUSA where the CDs, which were admittedly not covered securities, were represented to be backed by fictitious securities.  The Fifth Circuit identified the proper test from the defendant-oriented perspective, and held that “fraud is ‘in connection with’ the purchase or sale of securities if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.”  The court determined that “the heart, crux and gravamen” of the scheme was the representation that the CDs were a “safe and secure” investment because of its backing by other securities.  The court held that the representations about the purchase or sale of securities were only tangentially related to the fraudulent scheme, and thus were not “in connection with” such transactions.  As such, the Fifth Circuit concluded that SLUSA did not apply, and the cases should be remanded to the state court. 

            The U.S. Supreme Court’s anticipated decision has the potential to broadly affect the ability of Ponzi scheme victims to recoup their losses.  Typically, the individuals who perpetrate the fraudulent schemes have wasted the money entrusted to them, and the investors’ best chance to recover their losses is by establishing the liability of others who aided and abetted the fraud, or otherwise made the scheme possible in violation of state-law duties.  Victims of recent Ponzi schemes, including one that lead to the collapse of Peregrine Financial Group and another perpetrated by Scott Rothstein in Miami, may be directly impacted by the Court’s decision.  If the Supreme Court reverses the Fifth Circuit opinion, it will expand the reach of “in connection with” to imaginary securities with the effect of radically curbing investors’ ability to recover damages for losses suffered in Ponzi schemes.

U.S. Regulators Continue to Expand Actions Against Aiders and Abettors of Large-Scale Fraud

            Last month we wrote about the Commodity Futures Trading Commission’s unprecedented lawsuit against U.S. Bank for aiding and abetting the $1.2 billion fraud perpetrated by Russell Wasendorf, Sr., that resulted in the collapse of Peregrine Financial Group.  It was an opening salvo by a major U.S. regulator against a firm that did not fall within the traditional umbrella of the CFTC’s jurisdiction.

Adopting a similarly aggressive enforcement strategy, the Securities and Exchange Commission has charged TD Bank with violating several sections of the Securities Act for assisting the convicted Florida attorney, Scott Rothstein, in perpetrating a massive Ponzi scheme.  Rothstein’s scheme is now infamous.  Between 2005 and 2009, he used his South Florida-based law firm, Rothstein, Rosenfeldt and Adler, P.A., to sell non-existent discounted settlements to unsuspecting investors.  In particular, he claimed to represent plaintiffs who had reached confidential settlements that would be paid out in periodic distributions over an extended period of time.  He told investments that his purported clients wanted lump sum payments and were willing to sell their settlements at a discounted rate.  The settlements did not exist, and Rothstein’s investors lost enormous sums of money.

In furtherance of his scheme, Rothstein maintained several trust accounts at TD Bank, where the settlement proceeds were purportedly held.  A Regional Vice President of the bank falsely represented to investors that TD Bank restricted the movement of the settlement funds in those accounts for the exclusive benefit of the investors.  He also issued false “lock letters” stating that the accounts were irrevocably restricted so that the bank would distribute the funds only to specific bank accounts belonging to the investors.  Additionally, the bank also falsely assured investors that the trust accounts did maintained the account balances that Rothstein said they did.

Rothstein has been punished for perpetrated his vast Ponzi scheme.  He was disbarred by the Florida Supreme Court and convicted by the U.S. District Court and sentenced to 50 years in prison.  Federal regulators also sprang into action.  In 2012, the SEC initiated an enforcement action against two individuals who directed the largest number of investors to Rothstein.  Moreover, the Financial Crimes Enforcement Network (FinCen), an arm of the U.S. Department of Treasury, is the administrator of the Bank Secrecy Act that has the authority to assess civil monetary penalties against domestic financial institution.  FinCen hit TD Bank with a $37.5 million fine for the BSA failures that contributed to Rothstein’s fraud.

In an unusual move, the SEC, which does not regulate national banks, nonetheless has brought an enforcement action against TD Bank for violating various sections of the Securities Act in connection with its role in the Rothstein fraud.  For example, the SEC charged TD Bank with violating Section 17(a)(2) of the Act, which prohibits any person, in the offer or sale of any security, from obtaining money or property by means of any untrue statement or omission of material fact.  The agency also charged the bank with violating Section 17(a)(3), which prohibits any person, in the offer and sale of any security, from engaging in any transaction, practice or course of business that operates as a fraud or deceit upon the purchaser.

TD Bank chose not to fight the SEC’s charges.  Rather, it entered into a settlement with the Commission that agreed to entry of a cease-and-desist order and a civil monetary penalty of $15 million, in addition to the separately assessed FinCen penalty.  Additionally, TD Bank had to agree that, with regard to any lawsuit against it by a victim of Rothstein’s fraud, the bank would not argue for or benefit from any offset or reduction of any award of compensatory damages as a consequence of its payment of the civil penalty to the SEC.

While the SEC’s action stands alone as an important enforcement matter, it portends a welcome and broader effort by U.S. Regulators to aggressively pursue all those who are responsible for the mushrooming number of massive schemes to defraud that are devastating untold numbers of investors.

Ponzi Scheme Victims - All May Not Be Lost

Common wisdom says that victims of Ponzi schemes will never see their investment monies again. In most cases, that is likely true. But not always, and victims should be aware that sometimes they may have viable remedies to recover some or all of their losses.

The problem is enormous. Ever since the $50 billion Ponzi scheme masterminded by Bernard Madoff exploded two years ago, securities regulators have become more vigilant in pursuing these illegal investment scams. All of a sudden, we seem to be inundated with the disclosure of new Ponzi schemes nearly every week. According to a recent analysis conducted by the Associated Press, 150 Ponzi schemes collapsed in 2009, nearly four times the number that fell apart the year before, resulting in losses to victims of more than $16.5 billion. The Securities and Exchange Commission ("SEC") issues 82 percent more restraining orders against Ponzi schemes and similar securities fraud cases in 2009 as compared to 2008, and the FBI has opened more securities fraud investigations than ever before. Once the final statistics for 2010 are available, there is no reason to believe they will show any improvement.

Any victim of securities fraud faces potentially devastating losses. For investors who lose money due to the misconduct at brokerage firms, the opportunity to recover their losses through arbitration exists. Because most Ponzi schemes are run by fraudsters unaffiliated with brokerage firms, the collapse of these schemes often leaves victims with no recourse.

Recovery of losses, however, is not always out of the question. In 2010, the investment fraud lawyers at Block & Landsman were hired by a couple who were victimized by a woman who is now imprisoned in a federal penitentiary for operating a massive Ponzi scheme. The fraudster represented to our clients that her firm was selling interests in a bond yielding 8% interest and that they could pull their money out any time they wanted. The investors believed these promises and wire transferred their investment to a bank where the schemer said the money needed to be deposited. As soon as the transfer was complete, however, the fraudster withdrew the funds and used them for personal expenses. Although the investors soon discovered the fraud, their money was already gone, and they felt all was lost.

Fortunately for our clients, they may find relief. The bank they transferred their money to has an affiliated brokerage firm. The woman now in prison used to be registered as a broker with that brokerage firm, until she lost her securities broker license for stealing money from a customer's account. Despite this background, the affiliated bank allowed her to open numerous accounts on behalf of others in her capacity as a financial adviser, ignoring the many red flags that she was continuing her criminal enterprise.

Securities Arbitration Update: Securities America Liable for Medical Capital Ponzi Scheme

The brokerage firm Securities America has been held liable in the first of what is expected to be dozens of securities arbitrations filed by investors who bought fraudulent securities representing interests in medical receivables offered by Medical Capital and other companies. A FINRA arbitration award was recently issued against Securities America for nearly $1.2 million in damages and legal fees in an arbitration case brought by an elderly investor who believed he was investing in safe securities.

Published reports point to dozens of brokerage firms that have sold Medical Capital securities. While Medical Capital is not the only firm alleged to have sold medical receivables under fraudulent circumstances, it was one of the largest, raising $2.2 billion between 2003 and 2008.

Medical Capital is now in bankruptcy. But, as the recent FINRA award shows, investors who purchased fraudulent medical receivable securities have the option to pursue brokers who sold these inappropriate investments. The investment fraud lawyers of Block & Landsman are currently pursuing claims involving fraudulent medical receivable securities. If you would like to consult with an investment fraud lawyer, please visit Block & Landsman's website.