A Ponzi scheme’s collapse almost always leads to a bankruptcy, receivership, or some other formal liquidation proceedings. In these proceedings, a trustee or receiver is charged with collecting as much funds as possible to pay creditors and defrauded investors. Among the methods used to recover assets are claims against investors who received returns from the Ponzi scheme. These claims are referred to as a “clawback actions.”
Clawback actions are incredibly controversial. How can an innocent defrauded investor now be subject to a lawsuit from the receiver or trustee? The subjects of these suits often argue that they had no knowledge of the fraud and had every reason to believe the money they withdrew from their investment accounts was legitimate profits. Most of the time, the money received by the defrauded investor has been spent – on a house, on college tuition payments, or on basic living expenses. Returning the earned income to a receiver can be devastating or impossible.
The legal theory is that money received by defrauded investors came from other defrauded investors, and all investors should be on equal ground. Clawback actions are supposed to be filed against “net winners” in a Ponzi scheme – meaning people that earned more than what they invested. In our practice, we have seen clawback actions filed against many people who were “net losers,” subjecting them to steep legal fees just to prove they did not make any money overall in the Ponzi scheme.
The money raised in clawback actions is supposed to be divided equally among the Ponzi victims, but questions remain as to where the money actually winds up. Bankruptcy trustees earn commission on assets recovered, and commissions and trustee legal fees are paid out of the funds raised by the trustee. So, money from defrauded investors often goes back to pay the lawyers involved in the clawback case rather than going to the Ponzi scheme victims.