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Innocent Investors in Ponzi Schemes Should be Entitled to Equitable Credit

By Paul Rubin

Once a Ponzi scheme is uncovered, investors deceived by the scam typically suffer two blows. First, they learn that they have been victimized by a con artist, that they may recover only a fraction of their investment, and that they will probably have to wait years before getting any of their money back. Worse, such investors are also likely to be sued in so-called “claw-back” lawsuits, in which a bankruptcy trustee seeks to compel them to return monies they received that they thought were either returns of principal or returns on their investments.

It is not uncommon for the investor to have invested new funds in the Ponzi scheme after receiving a distribution from the fraud perpetrator but before the ruse was uncovered. The question arises whether defendants in fraudulent conveyance actions should be entitled to a credit for such reinvestments. For example, assume the defendant originally invested $10 million, received a $1 million distribution in the form of a “dividend” one year later, and then invested an additional $200,000, all without having any reason to know that he or she was being deceived by a Ponzi scheme. Once the scheme comes to light, bankruptcy ensues and a trustee is appointed, should the trustee be permitted to recover the full $1 million from the investor? There is ample precedent to support the conclusion that it is appropriate for courts to exercise their equitable discretion so as to credit recipients of fraudulent transfers for pre-petition, post-transfer payments made to debtors.

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