Metropolitan News-Enterprise

 

Thursday, December 27, 2018

 

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Ninth Circuit:

Innocent Investor in Ponzi Scheme Must Forfeit Fees Gained by Enlisting Others

 

By a MetNews Staff Writer

 

A man who invested in what he thought was a legitimate company, but which was actually perpetrating a Ponzi scheme, and who urged family members, friends and others to put their own money in the venture was properly ordered to turn over to a receiver the nearly $750,000 he received in referral fees from the company, the Ninth U.S. Circuit Court of Appeals has held.

The majority opinion notes that the case is one of first impression in the Ninth Circuit and that there is “no consensus in other circuits” as to whether such fees are voidable. The panel nonetheless opted not to publish its views.

Two of the three members of the panel—Circuit Judge Kim Wardlaw and District Court Judge Robert W. Pratt of the Southern District of Iowa, sitting by designation—signed a memorandum opinion, filed Monday, which affirms an order by District Court Judge S. James Otero of the Central District of California.

SEC Action

Otero summarily adjudicated the appropriateness of receiver William J. Hoffman wresting the referral fees from defendant/appellant Howard Markowitz, and ordered judgment in favor of Hoffman. The receiver was appointed by the Securities and Exchange Commission, which brought a Sept. 17, 2014 action against Nationwide Automated Systems, Inc. (“NASI”), the Calabasas company perpetrating the Ponzi scheme.

The seized fees are to be applied to the benefit of later investors in the scheme, who were said by prosecutors to have been bilked out of a cumulative total of about $135 million. Hoffman’s personal lack of fraudulent intent was undisputed.

Senior Circuit Judge Dorothy Nelson agreed, in a concurring opinion, that the fees should be captured by the receiver, but differed with the majority on one point. Wardlaw and Pratt’s opinion says said that whether such fees must be relinquished depends on the circumstances in an individual case; Nelson maintained that referral fees in a Ponzi scam are always subject to disgorgement.

‘Reasonably Equivalent Value’

The case was decided under California’s Uniform Voidable Transactions Act which provides, in Civil Code §3439.08, that moneys paid to a third party by perpetrators of a Ponzi scheme may not be recouped where the recipient “took in good faith and for a reasonably equivalent value” provided to the enterprise. Markowitz contended that his services were worth to NASI what he was paid.

Monday’s memorandum opinion cites the Fifth Circuit’s 2006 opinion in Warfield v. Byron. There, the court said that “[i]t takes cheek” for the defendant, though an investor, himself, “to contend that in exchange for the payments he received, the… Ponzi scheme benefited from his efforts to extend the fraud by securing new investments.”

In Wayfield, the Fifth Circuit summarized a 1993 Bankruptcy Court decision as saying that “investors who talked up Ponzi scheme…conferred no value” because the conduct “exacerbates harm to defrauded” persons who were late investors.

The Ninth’s Circuit’s opinion declares:

“We need not reach the question of whether referrals to a Ponzi scheme are per se voidable because they never provide value. We find, however, that the reasoning in Warfield compels the result in this case. Markowitz concedes that the only service he provided in exchange for referral fees was to refer others to the Ponzi scheme. On this set of facts, we conclude that Markowitz’s referral fees do not constitute ‘reasonably equivalent value’ and are thus subject to disgorgement.”

Nelson’s Opinion

Nelson wrote:

“…I would hold that when a third-party receives payment in exchange for referring investors to a Ponzi scheme, the payments are per se voidable because investor referrals do not provide value to the Ponzi scheme. Rather, each referral increases the Ponzi scheme’s liabilities and its inevitable insolvency”

She went on to say:

“Markowitz’s slippery slope argument is unpersuasive because it fails to recognize the material differences between an ordinary vendor (e.g.. landlord, utility company, or shipping service) and a third-party agent paid to recruit new investors to a Ponzi scheme, like Markowitz. While ordinary vendor sendees technically allow the Ponzi scheme to continue, the connection between those services and increased creditor liability is indirect and attenuated. For example, while a vendor like FedEx may assist a Ponzi scheme’s operations through its shipping services; those services do not inherently increase the scheme’s liabilities to its investors/creditors. Contrarily, investor referrals directly create increased creditor liabilities and lead to the scheme’s eventual insolvency.”

The case is Hoffman v. Markowitz, 17-56290.

Allegations of Complaint

According to the Sept. 17, 2014 complaint filed by the SEC against Nationwide Automated Systems, Inc., investors were told they “could purchase ATMs from NASI, and then lease them back to NASI in return for ‘rent’ of 50 cents per ATM transaction, with a guaranteed investment return of at least 20% per year.” However, it was set forth, “none of that was true,” explaining:

“Legitimate ATM transaction revenue represented only a tiny fraction—less than 2%—of NASI’s actual revenue. The vast majority of NASI’s revenue was comprised of new investor funds. To an overwhelming degree, therefore, investor funds were not being used to acquire, place, operate, and maintain the thousands of ATMs that NASI said it had sold to them, but were instead being used to pay guaranteed returns NASI already owed to earlier investors. Defendants also did not actually own many of the ATMs they had ostensibly bought and allegedly sold to investors. In fact, Defendants required investors to contractually promise that they would never contact the locations where their ATMs were supposedly located, all to ensure that no one could discover Defendants’ fraud.”

Criminal charges were filed on Dec. 16, 2014, against NASI’s owners, Joel Gillis and Edward Wishner, charging them with mail fraud, wire fraud, and conspiracy. They were convicted, and on Nov. 16, 2015, Otero sentenced Gillis, 75, to 10 years in prison and Edward Wishner, 77, to a 9-year term.

 

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