Court confirms difference between Ponzi schemes, intentional misconduct

In 2012, The 5th Circuit Court of Appeals reversed a district court decision that would have ordered the American Cancer Society to pay back nearly a quarter million dollars in donations. The court came to its decision after deliberating whether the actions of the donating company constituted a Ponzi scheme and thus entitled investors to their money back.

Investigation of fraud leads to motion to recover funds

In 2009, the Securities and Exchange Commission (SEC) launched an investigation into the securities trading of several related companies, collectively called "Giant" in the court documents. The SEC was looking for evidence of securities fraud.

The SEC found that Giant collected millions of dollars from investors who invested in unregistered securities with the company. The investors were told the majority of their money was funding operational costs, but it really went to personal expenses and other business accounts. No money was given back to the investors; however, the company did donate $240,000 of these funds to the American Cancer Society.

During the investigation, but prior to the SEC filing its civil complaint, the individual acting as the receiver over Giant's assets filed a motion to recover the money given to the American Cancer Society, claiming the money donated to the charity qualified as fraudulent transfers in a Ponzi-like scheme and thus, recoverable. The district court agreed and the American Cancer Society appealed.

Court of Appeals reverses district court decision

At heart of the receiver's motion was the contention that Giant's fraudulent actions constituted a Ponzi scheme. In a Ponzi scheme, an investment company pays investors fake returns with money brought into the scheme by new investors. No securities actually exist or the investment company invents unregistered securities to perpetrate the fraud.

Ponzi schemes promise investors high returns for little or no risk. They collapse when the company cannot recruit enough new investors to cover payments to current investors. Ponzi schemes were brought back into recent memory in 2008, when it was discovered that Bernie Madoff was conducting a massive Ponzi scheme.

The Court of Appeals reversed the district court's decision because it found no evidence that Giant's actions constituted a Ponzi scheme as the receiver claimed. As a result, Giant never gave money back to investors.

Giant case reveals distinction between Ponzi schemes and intentional misconduct

The Giant case upholds the fact that while a Ponzi scheme is a type of securities fraud, not all types of securities fraud are Ponzi schemes. While Giant was found to have defrauded investors in its use of unregistered securities that were not used as the company claimed, its actions are not a Ponzi scheme.

Securities fraud occurs when a company or money manager intentionally misrepresents investment information to its investors. For example, companies accused of securities fraud may have allegedly withheld information from investors or provided them false information or bad advice. Insider trading also constitutes securities fraud.

In a securities fraud case, plaintiffs must prove that an investment company intentionally or recklessly failed to accurately inform investors of facts about their accounts or the markets that they would have used to make investment decisions. If there is no proof that the company acted intentionally or recklessly, it will be very difficult for the plaintiff to win the suit. To help ensure your defense is successful, contact an experienced litigation and appeals attorney.