Over the last few years, the prevalence and prosecution of Ponzi schemes has increased dramatically. As investment vehicles have become more sophisticated, unscrupulous businessmen have sought to capitalize on unsuspecting investors with the promise of staggering returns on investment, particularly in times of financial uncertainty or instability. Given the recent increase in the prosecution of these schemes, including several high profile cases across the country, it is clear that persons organizing and operating such frauds face criminal sanctions. What is less clear, however, are the consequences of these schemes, including: how persons convicted of engaging in Ponzi schemes will be sentenced; how investors might recover their losses; and what impact will be felt by investors who benefited from the returns.

Ponzi schemes and their history.

A Ponzi scheme is a fraudulent system created by a swindler in order to entice investors with the promise of massive gains, and which creates the illusion of solvency by paying off early investors with capital raised from later entrants. The Ponzi scheme depends upon new entrants continuing to invest in the scheme; when new entrants become scarce or investors withdraw, the Ponzi scheme collapses.

Ponzi schemes are named after Italian immigrant and Boston businessman Charles Ponzi who, in 1919 and 1920, persuaded thousands of people to sink millions of dollars into a scheme whereby Ponzi purchased international reply coupons at low exchange rates and then redeemed the coupons for U.S. postage stamps worth higher values.1 Ponzi would then sell the postage stamps at the higher value, and lure investors with promises of a 50 percent return on their investment in 90 days.2

Though Ponzi is the scheme’s namesake, he was not the original practitioner. Such schemes date back to 1899 when New Yorker William Miller bilked investors out of $1 million— more than $20 million in today’s dollars.3

Although Miller and Ponzi set the standard for Ponzi schemes in the late 19th and early 20th centuries, the schemes did not become prevalent in the United States for several decades. In fact, it was not until recently—in the 1980’s and 1990’s—that Ponzi schemes began cropping up with increasing regularity.4 In 1985, a San Diego currency trader named David Dominelli bilked more than 1,000 investors out of approximately $80 million.5 During the 1990’s, Florida clergymen fleeced nearly 20,000 people out of $500 million.6 The organizers of both scams were prosecuted for their crimes; Dominelli pled guilty to four felony counts and was sentenced to 20 years in prison,7 while the five church officials responsible for the Florida scheme were convicted at trial of a combined 72 felony counts of fraud and conspiracy and sentenced to over 90 years in prison.8

Recent prosecutions of persons involved in Ponzi schemes. Over the last several years, the government has continued to investigate and prosecute persons responsible for organizing and operating Ponzi schemes. Perhaps the most high profile prosecution was that of Bernard Madoff, the former Nasdaq Stock Market Chairman and founder of Bernard L. Madoff Investment Securities LLC who, over the course of 20 years, bilked investors out of approximately $50 billion.9 Madoff’s scheme has been characterized as the largest (in terms of money) and most widespread to date. In March 2009, Madoff pled guilty to 11 federal offenses, including securities fraud, wire fraud, mail fraud, and money laundering, and was given the maximum sentence of 150 years in prison.10

In 2008, a federal grand jury in Minnesota indicted Thomas Petters, a Minnesota businessman and the former CEO and chairman of Petters Group Worldwide, on 20 counts of mail fraud, wire fraud, conspiracy, and money laundering.11 The government accused Petters of turning his company into a $3.65 billion Ponzi scheme, in which he fabricated business records to lure investors into believing that they were financing the purchase of electronic goods that would be resold to big-box retailers.12 Petters was tried by a jury and, on December 2, 2009, convicted on all 20 counts.13 Petters faces a potential maximum sentence of 335 years in prison.

In June 2009, Texas financier Allen Stanford was charged in a 21-count indictment with orchestrating a $7 billion Ponzi scheme centered around the fraudulent sale of certificates of deposit to approximately 30,000 investors.14 Stanford has pled not guilty to charges of fraud, conspiracy, and obstruction. If convicted of all charges, Stanford faces up to 250 years in prison.15

Just a few months later, federal prosecutors in Miami filed criminal charges against Scott Rothstein, a lawyer and former executive and chairman of the now-defunct Rothstein Rosenfeldt Adler law firm, accusing Rothstein of operating a $1.2 billion Ponzi scheme.16 The indictment alleges that Rothstein sold stakes in fictitious settlements that he claimed his law firm had negotiated in employment-related cases.17 Investors were guaranteed a 20 percent return on their investment in as little as three months.18 Rothstein has pled guilty and is currently awaiting sentencing. These examples represent only a few of the investigations and prosecutions of Ponzi schemes currently underway across the country. The recent cases make clear that persons involved in Ponzi schemes will be charged and face significant penalties if convicted.

Sentencing for Ponzi schemes. As with most significant economic fraud matters, the United States Department of Justice normally prosecutes those involved in Ponzi schemes due to the complexity of the matters and the resources and expertise required to prosecute. Upon conviction, the federal sentencing guidelines, although no longer mandatory for federal judges to follow, will guide the court in determining the appropriate sentence. As in all economic frauds, the amount of the loss will be a significant factor in determining the sentence.19 Additionally, the defendant could receive an increased sentence for: stealing from multiple victims;20 operating a substantial part of the scheme from overseas;21 operating a sophisticated fraud;22 deriving more than $1 million from a financial institution;23 substantially jeopardizing the soundness of a financial institution or endangering the financial security of 100 or more victims;24 being an organizer of the scheme;25 and abusing a position of trust or use of a special skill.26

The federal sentencing guidelines use a numerical system to assign points to the activity. The more points, the more imprisonment. Additionally, there are six different categories a person can be placed into based upon their criminal history. After the points and the criminal history is determined, those values are reduced to a matrix which provides for sentencing ranges.

Recovery for victims. In economic fraud cases, victims are entitled to an order of restitution making the convicted defendant responsible for the repayment of the loss. Practically, however, this seldom leads to recovery. In many of the recent Ponzi schemes, neither DOJ nor the courts are relying upon the restitution laws to assist the victims but are instead taking a more proactive approach in order to seek recovery. DOJ has initiated seizure warrants to take control of assets formally controlled by those charged in Ponzi schemes, thus ensuring that these assets will not be dissipated before restitution can be ordered. Additionally, courts are often appointing receivers to be responsible for the administration of the assets formally under control of the defendant.

Receivers have initiated “claw back” actions against those investors who benefited from the Ponzi scheme under the theory that the money they gained on the return of their initial investment was money that had been fraudulently acquired by the Ponzi artist from victims. This practice is justified by the receivers under a fraudulent conveyance theory under the bankruptcy code. While this theory of recovery may reach the return on the initial investment, it should not allow the receiver to also obtain the initial investment that was returned to the investor, unless it can be shown that when the investor redeemed his initial investment he was aware of the fraud.

Conclusion. While the prevalence of Ponzi schemes has increased dramatically, the attendant collateral litigation has spawned exponentially. Lawsuits involving claw backs, bankruptcy litigation, forfeiture and distribution of assets, and allegations of improper due diligence by investment managers are now becoming common in each jurisdiction that encounters a criminal Ponzi scheme. While Charles Ponzi is long dead, his claim to fame appears to prosper, to the detriment of thousands of victims nationwide.

Thomas Petters’ potential guideline sentencing issues:

  • 7 Base Offense Level
  • +30 [Loss is more than $400 million]
  • +4 [More than 50 victims]
  • +2 [Sophisticated fraud]
  • +2 [Receiving more than $1 million from a financial institution]
  • +4 [Substantially jeopardized soundness of financial institution]
  • +4 [Leader of group of 5 or more]
  • +2 [Obstruction of justice]
  • Total Offense Level = 55
  • Criminal History Category = I
  • Guideline Range = Life Imprisonment

However, as none of the offenses that Thomas Petters was convicted of carry a statutory life sentence, the Judge will be required to impose consecutive sentences to meet the overall length of imprisonment that exceeds any one offense’s statutory maximum.