Welcome to the age of the Ponzi Scheme, the result of the non-regulation of “hedge funds.” Madoff, Nagel, Stanford, Spitzer, the list goes on and on, millions, tens of billions of dollars swindled by Ponzi scheme scam operators, always, or at least most often leaving investors with nothing, except whatever meager sum the government may have seized, or that the Trustee seeks to collect in claw backs from other investors.
Because these operators by definition have no meaningful assets, lawyers, many of whom represent investors on a contingent fee basis, have no interest in these cases. However, sometimes all is not lost, particularly where the person or entity recommending the purchase of the Ponzi Scheme investment is associated with a registered broker dealer, or is an insured registered investment advisor.
Often the lines between who is a stockbroker and is duly registered to sell securities, and who is an investment advisor, or simply an unregistered promoter acting as an investment advisor is blurred. In May 1998, in Notice to Members 98-38, FINRA observed that “some associated persons,” working in geographically dispersed offices, “are involved in other business enterprises, such as insurance, real estate sales, accounting, tax planning, or investment advisory services. activities.” While the [FINRA] does not encourage of discourage such arrangements,” the purpose of this Notice is to remind members of their supervisory obligations for all of their associated persons and offices,” and that “Member firm must supervise all of their associated persons – regardless of location, compensation, employment arrangement or registration status – in accordance with the NASD By-Laws and Rules.
The North American Securities Administrators Association
As Denise V.Crawford, the Texas Securities Commissioner and President, The North American Securities Administrators Association, Inc., testified before the House Financial Services Committee that: “The migration of stockbrokers into the advisory arena through the marketing of brokers as ‘trusted advisers’ and ‘financial advisors’ over the years has fueled confusion among investors as to the services provided by stockbrokers and investment advisers as well as the level of protection.” Capital Markets Regulatory Reform: Strengthening Investor Protection, Enhancing Oversight of Private Pools of Capital, and Creating a National Insurance Office (NASAA Oct. 6, 2009); See also, Investment Advisers Should Adhere to a Single, High Fiduciary Standard, Says CFA Institute (Sept 11, 2009).
As noted by securities regulators, the structure of non-traditional firms, where registered representatives may be engaged in selling insurance, annuities and providing other services (including the sale of unregistered investments), has made it inherently difficult for such broker-dealers to properly design, implement, and maintain a supervisory structure capable of preventing fraud as complained of here. In fact, the SEC has found that the “mere existence of a remote office where a registered representative is engaging in outside business activity constitutes a red flag where, by the nature of the business, the representative creates a potential vehicle by which he may carry out or conceal violations of the securities laws.” See, In the Matter of Prospera Financial Services, Inc., 73 S.E.C. 935 at 6 (Sept. 26, 2000). Such activity has been at the heart of recent cases, both civil and regulatory, involving non-traditional firms and their “independent contractors.” See, e.g., In re Royal Alliance Associates, Inc., 63 S.E.C. Docket 1601 (Jan. 15, 1997)(inadequate system of effective supervision over geographically dispersed brokers); See also, In re Consolidated Investment Services, 58 S.E.C. 699 (Dec. 12, 1994); In the Matter of Prospera Financial Services, Inc., 73 S.E.C. 935 at 6 (Sept. 26, 2000); In re New York Life Securities, Inc., 68 S.E.C. 102 (Sept. 23, 1998); See also, In Re Ameritas Investment Corporation, FINRA AWC No. 06-6364302 (Aug 6, 2009)(FINRA enforcement action against Ameritas Investment Corp., a Nebraska-based dually registered broker-dealer and investment advisor, fined $100,000 for failure to supervise the investment advisory activities of one of its brokers in connection with the sale of unsuitable investments and related violations).
However, broker-dealers have responsibility for the extracurricular activities of their registered representatives, and the offices from which their registered representatives operate, when it comes to the recommendation and sale of Ponzi schemes. Lustgraaf v. Behrens, 619 F.3d 867 (8th Cir. 2010)(plaintiffs stated a claim for control person liability against a broker-dealer whose registered representative conducted a Ponzi scheme, even though the fraud was conducted through a third-party brokerage firm); Harrison v. Dean Witter Reynolds, Inc., 79 F.3d 609 (7th Cir. 1996), cert. denied, 519 U.S. 825 (1996)(broker-dealer liable for Ponzi scheme run by two registered representatives in Dean Witter’s Boca Raton branch office, despite that customers did not deal directly with Dean Witter in purchasing them); Jairett v. First Montauk Securities Corp., 153 F.Supp. 2d 562 (E.D. Pa. 2001)(broker-dealer “control person” liable for registered representative’s sales of mortgage interests through a wholly separate entity); Hunt v. Miller, 908 F.2d 1210 (4th Cir. 1990)(broker dealer responsible for registered representative’s sale of limited partnership interests sold away from firm); Martin v. Shearson Lehman Hutton, Inc., 986 F.2d 242 (8th Cir. 1993), cert. denied, 114 S.Ct. 177 (1993)(Shearson’s status as employer [of the registered representative] is sufficient to establish it as a controlling person); See also, In re Royal Alliance Assoc., Exchange Act Rel. No. 38174, 1997 SEC Lexis 113 (Jan. 15, 1997) (disciplining firm that failed to stop two branch managers from selling Ponzi schemes); In re Kolar, Exchange Act Rel. No. 46127, 2002 SEC Lexis 1647 (June 26, 2002) (suspending Dean Witter supervisor who failed to detect and prevent broker’s sales of investments, promoted as collateral-backed promissory notes); In re Kunz, Exchange Act Rel. No. 45290, 2002 SEC Lexis 104 (Jan. 16, 2002) (disciplining broker-dealer that failed to prevent broker’s sales of “Wholesale Mortgage Loan Participation Interests”); In re Consolidated Investment Serv., Exchange Act Rel. No. 36687, 1996 SEC Lexis 83; 52 S.E.C. 582 (Jan. 5, 1996) (suspending firm for failing to detect and prevent broker’s sales of $5 million of non-existent “Agency CD Notes”); In re Stuart, Coleman & Co., Exchange Act Rel. No. 38001, 1996 SEC Lexis 3266 (Dec. 2, 1996) (disciplining firm where branch manager had permitted registered representatives to sell fraudulent limited partnership interests, even though firm had explicitly refused written request for permission).
Most often persons or entities recommending the sale of Ponzi scheme have failed to undertake any meaningful due diligence regarding the Ponzi scheme. Often they have received substantial undisclosed compensation, and often are party to the distribution of false and misleading written statements concerning the performance of these funds.
The employers or principals of these persons or individuals are responsible for their conduct under the common law agency principles, the doctrine of respondeat superior, and as control persons pursuant to Section 20(a) of the Exchange Act of 1934, 15 U.S.C. § 78t.
Exchange Act of 1934
Section 20(a) of the Exchange Act of 1934, 15 U.S.C. 78t(a) provides that:
every person who directly or indirectly controls and person liable under any provision of this chapter or any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the acts or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a); See also, Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1573 (9th Cir. 1990)(“Congress adopted Section 20(a) in an attempt to protect the investing public from representatives who were improperly supervised or controlled”). In order to establish liability under Section 20(a), a plaintiff need only allege that the controlling person had knowledge, or at least a duty to know, of the alleged wrongful activity, and the power or ability to control or influence the affairs of the controlled persons. Arthur Children’s Trust v. Keim, 994 F.2d 1390, 1398 (9th Cir. 1993); Powers v. Eichen, 977 F. Supp. 1031, 1044-45 (N.D. Cal. 1997) (“plaintiff need not show day-to-day control of affairs, only that defendants had possession of the power to influence in order to state a claim under Section 20(a)”). Hollinger, 914 F.2d at 1572 n.16 (same); Safeway Portland Employees’ Fed. Credit Union v. C.H. Wagner & Co., 501 F.2d 1120 (9th Cir. 1974) (same); See also., Platsis v. E.F. Hutton & Co., Inc., 642 F. Supp. 1277 (W.D. Mich. 1986) (liability will attach under Section 20(a) where control person exercises control in the activities or operations of the control person); Bull v. Chandler, 1987 Transfer Binder, Fed. Sec. L. Rep. ¶ 93,257 (CCH) (N.D. Cal. 1987) (participation of control person in activities of controlled person sufficient to confer liability).
Accordingly, all may not be lost for investors in Ponzi schemes.
Guiliano Law Group
Investors suffering losses or damages from such conduct may be able to recover their investment losses. Our practice is limited to the representation of investors in claims, for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to you unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
