Charles Ponzi – the original Ponzi Scheme
A federal judge in Tampa has barred a Swiss hedge fund from making claims against an alleged Ponzi scheme. In an opinion that could have far reaching implications in other investment fraud cases, the court said the fund shouldn’t be allowed to participate in the claims process because it missed too many red flags before investing funds in the scheme.
The case arose after Arthur Nadel allegedly stole $330 millions from investors in a Ponzi scheme. The court appointed a receiver to find and liquidate assess on behalf of investors. One of the creditors was a Swiss bank who filed a claim on behalf of two investment funds. The receiver said the funds shouldn’t participate in any recovery because they were sophisticated investors. The funds claimed they should be treated like any other investor.
In a surprise ruling, the court agreed with the receiver and denied the funds’ claims. Federal law allows a receiver to deny a claim if the claimant acted in bad faith. This sometimes occurs if the claimant had “unclean hands” or participated in the fraudulent conduct giving rise to the losses. Here, the court stretched the definition of “good faith” and determined the fund had actual knowledge or “inquiry notice” of the fraud. Because the funds “should have known” of the fraud, the court determined they were not good faith claimants.
Until now, the bad faith needed to deny recovery meant that the claimant had to have some active role in the fraud. In this case, however, Judge Richard Lazzara greatly expanded the doctrine of bad faith to include mere knowledge or imputed knowledge.
Presumably no investor would turn money over to a Ponzi scheme if they had actual knowledge of a fraud. That leaves “inquiry notice” as the determining factor. Although “inquiry notice” was not defined by the court, the opinion makes clear that the claimant hedge funds didn’t act in good faith because they were sophisticated investors and should have heeded the many red flags surrounding the investment.
The red flags included the fact that the promoter was a disbarred attorney with a history of dishonesty problems and another insider was the subject of a prior cease and desist order. Because the hedge funds didn’t do proper due diligence, they apparently did not act in good faith and cannot participate in any recovery.
The court’s decision marks a radical departure from existing case law. It establishes precedent to disallow other claims submitted by sophisticated investors. If the case is not overturned on return, institutional investors and hedge funds will be forced to perform more due diligence before investing. Hedge funds and institutional investors, of course, often get their monies from individual investors. One could think of future scenarios in which individuals who invest directly with a Ponzi scheme promoter have a better chance of recovering than those who invest through a hedge fund.
A new and radical trend or reversible error? We will watch this case closely.
About the author. Brian Mahany is an attorney representing victims of Ponzi schemes including individuals, hedge funds, institutional investors and receivers. He can be reached at or by telephone at (direct). Brian also writes a daily tax and fraud blog called Due Diligence.