Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Friday, April 5, 2013

State Restitution Funds to Ponzi Scheme Victims: A Good Idea?

Posted by Kathy Bazoian Phelps

   Should a state provide funding to reimburse victims of Ponzi schemes? Is it possible for states to promulgate fair and comprehensive laws in this regard? Does funding at the state level to reimburse victims give those victims a disincentive from exercising caution and avoiding the frauds in the first place? These are difficult questions that a few states have already decided and others may join. Laws are on the books in Indiana and Montana, and New Hampshire is thinking about it.


   In 2010, Indiana became the first state to adopt legislation establishing a "Securities Restitution Fund." The law gave the Indiana Securities Commissioner the ability to award victims a portion of their losses up to $15,000, or 25% of unrecovered awards, whichever is less. Eligible victims are required to show proof that restitution was awarded by a court or administrative agency. The fund was established with an initial $2 million from Securities Division fines paid by violators of the Indiana Securities Act. The Fund continues to be derived from the Enforcement Fund, which is funded by fines and does not depend on any tax dollars. The Indiana legislation is here. For more information about the Indiana Securities Restitution Fund and to apply for restitution from it, click here. Frequently asked questions are here.
Pros and Cons of Indiana Restitution Fund:

Good Faith Considerations: The law contemplates consideration of "whether a victim contributed to the infliction of the victim's monetary injury." Additionally, no restitution assistance shall be awarded if the victim participated or what happens if a victim were overly greedy or willfully blind to the fraud when deciding to invest, or how that kind of determination should be made. The issue of good faith is often an extremely costly and hotly contested issue when the issue arises in litigation in Ponzi scheme cases.

Double Recovery Considerations: The law also contemplates a right of subrogation for the state, which presumably would solve the problem of a potential double recovery by the victim. On the other hand, the law provides that the state could commence its own action or intervene in an action brought by the victim, but it is hard to imagine the state pursuing this course of action, particularly where the amount at issue is capped at $15,000.

Scope of the Class of Victims Covered: It is noteworthy that this Restitution Fund only applies to victims of securities violations. Victims of other types of Ponzi schemes – of which there is an infinite variety – therefore appear out of luck. A Ponzi scheme can involve just about any business model, not just securities. One must question why securities Ponzi scheme victims are afforded special treatment under this law.

Impact of the Fund: And then there is the over-arching question of whether any of this matters because it is unclear how often the Fund will be used. On August 23, 2012, Indiana authorities announced in a press release, available here, that the first payment from the Securities Restitution Fund, in the amount of $15,000, would be made to Steve Brodie. Brodie lost his life savings of $400,000 to Keenan Hauke, who was the manager of a hedge fund called Samex Capital Partners, LLC, and who bilked over 30 investors out of $7 million to $10 million. Hauke pled guilty to federal securities fraud charges and was sentenced to over 10 years. Although $15,000 makes just a small dent in the total damage, at least it’s something.

   In 2011, Montana established the "Securities Restitution Assistance Fund," to be financed by court-ordered contributions from white collar criminals and those who voluntarily contribute to the fund. The relief to be provided is phrased as follows: "There is an account in the state special revenue fund to the credit of the commissioner for use only for securities restitution assistance. . . The fund may be used by the commissioner only to pay awards of restitution assistance under this part." The purpose is stated to be "to provide restitution assistance to victims who: (1) were awarded restitution in a final order issued by the commissioner or were awarded restitution in the final order in a legal action initiated by the commissioner; and (2) have not received the full amount of restitution ordered before the application for restitution assistance is due." Victims can receive the lesser of 25% of their losses or $25,000, and only if "the person ordered to pay restitution has not paid the full amount of restitution owed to the victim."

   Recently, the Montana law was enhanced. On March 7, 2013, Montana Governor Steve Bullock signed House Bill 81 into law, making public funds available for the Securities Restitution Assistance Fund. It authorizes the deposit of a percentage of securities registration, filing or renewal fees into the Fund.

   The original 2011 law is here. Montana House Bill 81 is here. For more information about the Montana Restitution Assistance Fund and to apply for restitution from it, click here. The regulations of the Montana Securities Department relating to the fund are here.

   The first payment from this fund, in the amount of $13,750, was made in July 2012 to Reece Cobeen, who had invested $55,000 in phony promissory notes sold by Terry Parks, purportedly to help rebuild homes in Louisiana after Hurricane Katrina. Parks promised Cobeen a 24% annual return on the investment. Parks was convicted on three counts of investment fraud and was sentenced to 10 years
Pros and Cons of Montana Restitution Fund

Good Faith Considerations: This law appears to leave no room for consideration that a victim applying for relief may have unclean hands. It certainly could not be the intent to compensate those that are in cahoots with the violator, but what about those victims who were overly greedy and chose not to vet the investment program into which they were pouring their money? And, worse yet, what if laws like this provide some assurance to would-be victims that the state will have their back if something goes wrong, leaving an investor emboldened to gamble on a high-risk high-reward investment without conducting proper due diligence? While this most certainly cannot be the intent or objective of the law, more detailed guidelines prohibiting payments to those not in good faith could go a long way in removing the disincentive to conduct due diligence that this law arguably creates.

Double Recovery Considerations: The law also does not appear to have contemplated the possibility that victims may have received recoveries from other sources, such as payment in connection with a claim filed in a bankruptcy case, or a restitution or restoration payment made by the federal government in connection with a related forfeiture proceeding.

Scope of the Class of Victims Covered: Like Indiana, Montana has limited this source of recovery to victims of securities violations only. One only needs to glance at the newspaper to see the wide variety of non-securities frauds that this excludes.
New Hampshire

   Will New Hampshire join Indiana and Montana in providing relief to fraud victims?

   New Hampshire Senate Bill 180 is entitled, "Establishing a recovery fund for victims of the Financial Resources Mortgage (FRM) fraud, continually appropriating a special fund and making an appropriation therefor." At present it has been favorably reported out of a Senate committee and is awaiting final action. The New Hampshire fund would deal with victims of just one fraudulent scheme – Financial Resources Mortgage. It would establish the "FRM Recovery Fund," to provide "recovery assistance" to victims of the FRM fraud. The text of the required application form is set forth in the bill. The Fund will be financed with $3 million per year in tax money. New Hampshire Senate Bill 180 is here.

   FRM and its principals, Scott Farah and Donald Dodge, defrauded 250 investors out of about $33 million. Farah was sentenced to 15 years in prison. Dodge was sentenced to 6½ years.
Pros and Cons of New Hampshire FRM Restitution Fund

Scope of the Class of Victims Covered: The New Hampshire bill is far narrower than the already narrow restitution fund laws in Indiana and Montana, which are limited to securities fraud. This bill appears to appropriate tax dollars to pay victims of one particular fraudulent scheme – the FRM scheme only. One would think that tax-paying victims of different fraudulent schemes would find this quite objectionable.

Double Recovery Considerations: The bill requires an application process that takes into consideration mortgages retained and distributions received from the bankruptcy case or other sources.

Good Faith Considerations: The bill also contemplates that recovery shall be prohibited if it is determined that the claimant engaged in fraud or related wrongful conduct or the claimant profited from the scheme.
The Controversy: Victim Assistance vs. "Moral Hazard"

   Proponents of these types of state restitution funds have good intentions – let’s get money back to the victims. According to a press release issued when the Indiana law was enacted, the Indiana Secretary of State argued that the law will "protect investors from financial attacks," and "directly help victims avoid fraudsters and recover more of their losses when they do become victims of financial crimes." That press release is here.

   Opponents, however, argue that the state has no responsibility to compensate the victims of financial fraud, even if state agencies were negligent, and that "Doing so would also create a ‘moral hazard,’ an increased willingness to make risky bets that betters can lose and taxpayers can’t win." See "Editorial: Lawmakers should reject fund for FRM victims", Concord Monitor in New Hampshire, March 20, 2012. The editorial cites The Ponzi Scheme Blog for our listing of the many Ponzi scams that have been exposed. The Concord Monitor editorial is here.

   What do you think? Should the states assist fraud victims or does it create a moral hazard?

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