With the discussion in the press about the Social Security system and Ponzi schemes, it is relevant to ask the question, “What is a Ponzi scheme?” Our Lakewood based law team discusses what a Ponzi scheme is and whether or not social security is an example.
In a recent case before the Ninth Circuit Court of Appeal, a business that appeared to pay off its previous investors with the investments of new investors, began to seriously fail in 2009. When the company filed for bankruptcy, the US Trustee sued, arguing that funds were paid out pursuant to a classic Ponzi scheme framework, and thus, significant payments were made to defraud creditors.
The Court of Appeal, by Judge Sanchez, upheld the trial court’s instruction to the jury, regarding the definition of a Ponzi scheme:
A Ponzi scheme is a financial fraud that induces investment – often by promising high, risk-free returns within a relatively brief time period. In a Ponzi scheme, payments are made to investors or lenders from later investments or loans rather than from profits of the underlying business
venture. The fraud consists of transferring proceeds received from the new investors to previous investors, thereby giving other investors the impression that a legitimate profit-making business opportunity exists, where in fact no such opportunity exists. Distributing funds to earlier investors from the receipt of monies from later investors or lenders is the hallmark of Ponzi schemes.
The mere fact that a company has negative cash flows for several years is not alone sufficient to conclude that a company is a Ponzi scheme.
The district court’s jury instruction tracks, almost verbatim, how the Ninth Circuit has defined a Ponzi scheme for over thirty years. See, e.g., In re United Energy Corp., 944 F.2d at 590; In re AgriTech, 916 F.2d at 536; Donell, 533 F.3d at 767 n.2.The Court of Appeal pointed to the basic structure of the organization in question, and stated that there is an irrebuttable presumption that an organization that meets these criteria is a Ponzi scheme (i.e., a fraudulent business), and therefore, fraudulent. Hence, no proof of the perpetrator’s intent (mens rea) is necessary. Kirkland v. Rund (In re EPD Inv. Co., LLC), No. 22-55944, 2024 U.S. App. LEXIS 21363 at *1 (9th Cir. 2024).
The dissent, by Judge Clifton, argued that there should have been a mens rea instruction, because the fact that an investment business fails does not render it a Ponzi scheme. Moreover, 2009 fell in the middle of the Great Recession, which saw the failure of thousands of businesses, most of which were presumably not fraudulent.
Judge Clifton did not, however, analyze the specific facts of how the business operated. This shortcoming takes a lot of force out of his argument.
When it comes to the case of Social Security, high, risk-free returns are not part of the equation. Social Security is not a profit engine, and is not represented to be. Payments to each individual are relatively small. Payments to individuals are made based on the individual’s previous contributions, and Congressional enactments.
A Ponzi scheme is very strictly defined, and this definition has stuck for decades. It describes a particular type of business, but not the national retirement-assistance program of the Federal Government.
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Photo from Jesus Eca @ Unsplash.
