Are Ponzi Scheme Proceeds Dischargeable in Bankruptcy?
Let's say your client made a little money as an investor in (what turned out to be) a Ponzi scheme. The scheme was revealed, and a court ordered your client -- though she was never prosecuted in the scheme -- to pay back her share of ill-gotten gains.
The she declared bankruptcy.
How would the Tenth Circuit Court of Appeals treat her share of the take? Would it be nondischargeable debt?
In 2005 Marsha Schubert pled guilty to crimes related to a Ponzi scheme she used to defraud multiple investors of funds totaling over $9 million dollars. Her activities violated the Oklahoma security laws.
Robert Mathews and Marvin and Pamela Wilcox were investors in Schubert's Ponzi scheme.
After Schubert's conviction, the Oklahoma Department of Securities (the Department) sued over 150 of her investors, including Mathews and the Wilcoxes, to recoup funds distributed in the Ponzi scheme on the grounds of unjust enrichment, fraudulent transfer, and equitable lien. The Department later requested summary judgment only on the basis of unjust enrichment.
At the behest of the Department, Oklahoma courts found that early investors in a Ponzi scheme carried out by a third party have been unjustly enriched and are subject to disgorgement.
So Matthews and the Wilcoxes declared bankruptcy.
The bankruptcy court decided the debts were nondischargeable because they were "for a violation" of securities laws. The district court affirmed. But the Tenth Circuit Court of Appeals reversed, concluding that the judgment was a dischargeable debt.
Here, the Tenth Circuit Court of Appeals noted that, although the Department claimed the debtors were not innocent, it declined to prosecute them for securities laws violations.
That distinction is critical.
If the Department had successfully prosecuted the debtors, any judgment it obtained would no doubt be considered nondischargeable under § 523(a)(19).
Instead, the Department argued that the debts were immune from discharge merely because someone violated the securities laws, and the debtors coincidentally profited. According to the Department, permitting debtors, who were not personally found to be in violation of securities laws, to obtain relief from a judgment intended only to redistribute funds among multiple victims of a Ponzi scheme is in accordance with the plain language of the nondischargeable debt statute.
The Tenth Circuit Court of Appeals found that the Department's position conveniently served its ends, (and perhaps a public good), but the language of the statute could not reasonably be stretched that far.
- Oklahoma Department of Securities v. Wilcox (Tenth Circuit Court of Appeals)
- First Circuit: Fraud Judgment Means Debt is Nondischargeable (FindLaw's First Circuit Blog)
- Court Restates Claims Dischargeable in Bankruptcy (FindLaw's Third Circuit Blog)
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