Securities Fraud Encompasses Far More Than Just Ponzi Schemes

Most of us are familiar with the basic structure of a Ponzi or pyramid scheme: perpetrators promise victims high returns that will purportedly flow from legitimate sources of investment, but in reality the money collected from investors is the only source of funding. Money taken from new victims is used to pay the high rate of return promised to earlier investors, thereby creating the impression of a real, money-making enterprise and giving weight to the schemer's story.

When many of us hear the term " securities fraud," we think of something along the lines of the high-profile Ponzi schemes that have peppered the headlines in recent years, such as Bernard Madoff, Allen Stanford, and Scott Rothstein. It is true that a Ponzi scheme can be a form of securities fraud; however, financial improprieties of many different stripes may be prosecuted as securities fraud, and even in the courts the distinctions between them are not always clear.

Recent Federal Court Decision Clarified Ponzi Scheme Confusion

In one case recently heard before the Fifth Circuit Court of Appeals, several corporations and individuals operating within the oil-and-gas drilling industry were accused of securities fraud by the SEC. As is fairly standard in such cases, a receiver was appointed to take custodial responsibility over the defendants' assets. The receiver sought to recover amounts given by the defendants to, among other groups, the American Cancer Society based on the assertion that the defendants had engaged in a "Ponzi-like fraud."

The trial court approved the receiver's efforts - requiring the American Cancer Society to return the funds. But Fifth Circuit Court of Appeals reversed the trial court's ruling.

The defendants did raise a substantial sum of money from investors, who were told the bulk would be spent on operational costs (in reality, most of the funds were funneled into other business accounts or used by the defendants for personal expenses or charitable contributions). Importantly, however, not one penny was given back to investors.

Transfers made from a Ponzi scheme are presumed to be made with intent to defraud because Ponzi schemes are insolvent from the moment they are conceived as a matter of law. This means that payments made from the fruits of a Ponzi scheme are much more easily recoverable compared to payments originating from the fruits of some other types of securities fraud; if the defendants had engaged in a Ponzi scheme, the American Cancer Society likely would have had to return any donations unless it could raise a valid defense.

However, in a true Ponzi scheme, investor payouts are typically included in the modus operandi. The lack of even a single investor payout detracted from the receiver's claim of a Ponzi scheme, and thus the Fifth Circuit reversed the decision of the trial court, saying "not all securities frauds are Ponzi schemes."

Ponzi Schemes Just One Example of Misconduct Classified As Securities Fraud

The Fifth Circuit is right: clearly, not all securities frauds are Ponzi schemes. Yet, parsing out the differences can be challenging, and the recent Fifth Circuit reversal makes it clear that even trial courts can get it wrong.

Securities fraud is an umbrella term. It generally describes any illegal activity that involves the deception of investors or the manipulation of financial markets.

Ponzi schemes are one distinct type of securities fraud. But there are many others, including:

  • Advanced fee schemes - victims are asked to advance relatively small amounts of money to cover "taxes" or "processing fees" in exchange for the return of a much greater sum, only to have perpetrators abscond with the fees
  • Broker embezzlement - brokers misappropriate funds entrusted to them
  • Hedge fund fraud - hedge fund cases can be extremely complex, but often arise because investors were exposed to unreasonable risk
  • Corporate fraud - the possibilities are almost endless, but one example is intentionally making misstatements on a public company's financial reports
  • Late-day trading - purchasing and selling mutual funds after the close of a trading day, but manipulating the transactions so that they appear to have occurred before the market close

Securities fraud covers a broad range of illegal activities, but not every crime committed in the business or financial community is securities fraud. The bottom line: as a general rule, just remember that if something is illegal and it involves lying to investors or gaming a financial market, it is probably securities fraud. If the activity centers on using the proceeds from new investors to pay off earlier investors, it falls within the Ponzi scheme subset of securities fraud.

Been Victimized In a Ponzi Scheme or Some Other Financial Crime? Recoup Your Losses Through Legal Action

Have you been a victim of securities fraud? Many investors are not even immediately aware that they have been victimized or that a crime has taken place - but they often find themselves losing money and feeling as though something is not quite right.

Whether the top already had been blown off of a Ponzi scheme, or your suspicions have been aroused in the course of losing money in an investment, you may benefit from the assistance of a securities law firm. If you've been swindled or misled by your stockbroker or brokerage firm, you might be able to recover your losses through legal action. If you believe you have been a victim of securities fraud, contact a securities fraud attorney today.

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