In U.S. v. Simmons, 2013 U.S. App. LEXIS 24617 (4th Cir. Dec. 11, 2013), the Fourth Circuit overturned convictions on money laundering charges in connection with money that the defendant moved as part of his Ponzi scheme.
Keith Simmons operated a $35 million Ponzi scheme from 2007 to 2009 that defrauded 400 investors. Simmons was convicted on one count of securities fraud, one count of wire fraud, and two counts of money laundering. The court sentenced him to a prison sentence of 50 years. The fraud counts arose from Simmons’ role in the Ponzi scheme and not any particular instances of fraud. The money laundering counts arose from two discrete payments to investors made in 2008. Those two payments involved the diversion of “investor money back to other investors in Ponzi-fashion . . . to induce further investments by investors and their friends and family members.”
The court considered whether there was a merger of the money laundering and fraud charges under the Supreme Court case United States v. Santos, 553 U.S. 507 (2008). The key question considered by the Simmons court was whether the two payments giving rise to the money laundering convictions involved “proceeds” of unlawful activity or were “essential expenses” of maintaining the Ponzi scheme. The court further considered whether payments of purported returns to early investors are understood to constitute "essential expenses" of Ponzi schemes rather than transactions dispensing a Ponzi scheme's profits.
Simmons argued that it was improper to convict him separately of money laundering for payments that were essential to accomplishing his fraud, while the government argued that Simmons’ fraud did not depend on payments to investors and that the payments were not essential to the fraud.
The Fourth Circuit split on the issue. The majority concluded that the money laundering convictions cannot stand and that “a defendant cannot be convicted of money laundering merely "’for paying the essential expenses of operating the underlying crime.’" The court found, “The evidence admitted at Simmons's trial irrefutably established that the ongoing success of his Ponzi scheme depended on payments to earlier investors, including those payments charged in the money-laundering counts.” The court also noted:
In addition to the evidence proving that this particular Ponzi scheme relied on payments to early investors, such payments are understood to constitute essential features of Ponzi schemes. In fact, we have defined a Ponzi scheme as one ‘in which early investors are paid off with money received from later investors in order to prevent discovery and to encourage additional and larger investments.’ United States v. Loayza, 107 F.3d 257, 259 n.1 (4th Cir. 1997).The court cited other decisions that had reached the same conclusion, including United States v. Van Alystyne, 584 F.3d 803, 815 (9th Cir. 2009), in which the Ninth Circuit reversed the defendant's money-laundering convictions on the ground that the payments of purported returns to early investors were "inherent" to the defendant's underlying scheme to defraud.
The dissenting opinion in the Simmons case, however, noted that there is a distinction between an expense of the fraud, on the one hand, and payments to conceal the fraud and promote future frauds, on the other hand. The dissent argued that, in using a portion of the money Simmons obtained through wire and securities fraud, Simmons was then able to use the proceeds of the fraud to return money to investors. He was then able to engage in additional fraud from which he obtained additional proceeds “because the payments to Bazluki and Lux deflected potential suspicion that otherwise might arise with respect to his initial fraudulent transactions.”
In disagreeing with the majority, the dissent stated:
The majority could only make its analysis work if Simmons were convicted of some single crime prohibiting a Ponzi scheme because under a Ponzi scheme, the proceeds from earlier fraudulent transactions are used to engage in future transactions. But Simmons was not charged with a crime prohibiting a Ponzi scheme; he was charged with committing distinct crimes of wire fraud, securities fraud, and money laundering, and his payment of monies to investors who had already been defrauded was not an expense of the fraud; it was a transaction of money laundering.This decision in a criminal case highlights the differing approaches to Ponzi schemes in civil proceedings as well. Some believe that Ponzi schemes are a single tangled unit; others believe that activities that take place during a Ponzi scheme should be considered on a transaction-by-transaction basis. The debate arises in many contexts in Ponzi scheme cases, including:
- The Ponzi scheme presumption: Are all transfers made during the course of a Ponzi scheme necessarily made with actual fraudulent intent, or must a particular transfer have been made in furtherance of the Ponzi scheme?
- Amendment of complaints and the relation back doctrine: Are all claims to recover transfers made during the course of a Ponzi scheme related, or can they be viewed as distinct claims that may be time-barred if not timely brought?
- The ordinary course defense to preferences: Are all payments made during the course of a Ponzi scheme necessarily part of the fraud and therefore not ordinary, or can some payments be considered ordinary course?
- Constructive trust defenses to fraudulent transfer claims: Can a fraudulent transferee defendant assert that the money paid to it was earmarked or set aside in a trust for its benefit such that no property of the estate was actually transferred?
- Trust assertions over property of the estate: Can investors in a Ponzi scheme successfully argue that their funds are not property of the Debtor and obtain a priority in the return of the funds to them ahead of general unsecured creditors or other investors?