Ponzi Scheme

Fraud (Ponzi Scheme – Counsel)

May a law firm advise a client who may have once committed fraud to continue in his business without it also becoming complicit in the possible fraud or scheme?

A law firm may counsel a client who may have committed fraud to continue in his investment solicitation and promotion without being deemed complicit in the possible fraud or scheme, if it advises its client to affirmatively disclose all of the known and foreseeable risks and honesty respond to all inquiries made by both previous and prospective investors. For the purposes of this discussion, it is assumed that the defendant may have perpetrated a fraud by inducing investors to invest by creating misrepresentations and then perpetuated the fraud by “paying off” previous investors using funds provided by new investors.

The defendant may get charged with fraud as a result of filing for bankruptcy, although not because doing so is unlawful. Though he may not have had subjectively any mens rea to defraud his clients, he or she still may be found to have guilty intent. For this reason, there can be no guarantee that he will escape criminal prosecution. While filing for bankruptcy may lead to both criminal and civil charges against him or her, the payment of a just debt in contemplation of a bankruptcy filing is neither criminal nor fraudulent. However, it likely would be ineffectual, since preferential payments to creditors are voidable and thus could be “clawed back.” This may, nonetheless, be his only option to hope to avoid being charged with fraud in a criminal prosecution.

Obviously, an attorney may not advise his client to solicit new investors merely so he can satisfy his promises to previous investors. An attorney may advise his client, however, that after providing full disclosure (to his prospective investors) of the totality of the concomitant risks implicit in a given investment, and without making any false promises to induce such investors to invest, he may continue to use newly-received capital solely for expenses of the investment venture as long as he does not conceal the origin of the funds, should previous investors inquire.

If the venture has lost money, he or she would be well advised to disclose such information to prospective new investors. In addition, if the defendant believes the investment embodies characteristics of a Ponzi scheme (or another species of fraud), the defendant should not keep any proceeds for themselves. Rather, he should, “fall on his sword.” By providing full disclosure, the defendant is distinguished from Madoff — who refused to pay back his investors, to tell the truth or to apologize, until it was too late.

In providing full disclosure, the defendant will have a defense against being accused of making misrepresentations to his investors or otherwise defrauding them. Furthermore, if the defendant is found to have made promises and was not merely puffing, hadn’t profited and had instead sacrificed himself for the benefit of the group (as best as he or she could, by sacrificing his own interest for that of his investors), then this is the exact antithesis of Madoff’s approach.