Court Denies Investment Fund's Ponzi Loss Claim Based on Sophistication

Many red flags were waving in 2008. As set forth in detail in the Receiver’s response, there were many indicia that would lead a sophisticated institutional investor to question the prudence of investing in Valhalla. Not only had Nadel been disbarred from the practice of law in New York for dishonesty and fraud, but many judgments were outstanding against him in Sarasota County, Florida, along with divorce proceedings that alleged his defrauding of numerous individuals. With respect to Valhalla, a person disclosed in the private placement memorandum was Michael Zucker, the subject of a cease and desist order. Based on the record in these proceedings, there is no doubt that institutional investors like the Genium entities were placed on inquiry notice and cannot show good faith. 

[Editor's Note: In the interests of full disclosure, the author currently is part of the legal team representing the Receiver in this case and was involved in the instant proceedings.]

In what is believed to be a first in Ponzi scheme jurisprudence, an investment fund that purportedly lost over $1 million in a massive Ponzi scheme has been prohibited from participating in the ensuing claims process based in part on its sophistication and failure to spot "red flags."  In a decision Thursday afternoon, a federal district judge in the Middle District of Florida ruled that the submission of an incomplete proof of claim, as well as the failure to spot the "many red flags" surrounding the investment, could serve as the basis for denying the claim of a Swiss investment entity.  The decision could potentially have widespread ramifications in the niche area of Ponzi scheme litigation, especially in schemes involving a large amount of institutional investors.

The claim was originally submitted during the court-approved claims process stemming from the $330 million Ponzi scheme perpetrated by Arthur Nadel.  While a timely claim was submitted, the claim form was filled out by a Swiss bank that failed to disclose the beneficial (or legal) owner of the investment.  While the Receiver later asked the claimant to submit this information, this request was explicitly refused.  This information was important in evaluating the claim, for it was possible that the claimant (i) could have had multiple accounts; (ii) could have received other funds or transfers from the scheme not specifically tied to their investment, such as commissions; and (iii) could have been an insider or co-conspirator.  When attempts to obtain the information failed, the Receiver recommended denial of the claim, which was later affirmed by the court.

After the court approved the initial denial of the claim, an unrelated investment fund "purchased" the underlying claim, which has been known to occur in larger Ponzi schemes.  The purchasing entity continued to maintain that the claim was timely, and disputed that the original claimant was a sophisticated investment professional.  The Court ruled otherwise, finding that the investment fund was not similarly situated to the hundreds of innocent victims.  

The ruling is important for several reasons.  First, it may mark the first time that a "net loser" instititutional investor had a claim for their losses denied based on their sophistication.  Importantly, there was no "smoking gun," such as an incriminating email or letter; rather, simple due diligence such as a public records search would have shown that the fraudster had been disbarred for fraud, had several money judgments against him, and had previously filed an affidavit claiming he was indigent. An increased adoption of this standard could spur institutional investors to change their due diligence procedures when selecting an investment - especially when those investment procedures previously involved simply choosing funds with high returns.  Second, the ruling confirms that an investor's good faith may be considered in the claims process, and an investor may not blindly make an investment when numerous "red flags" should have put them on notice of the possible illegitimacy of the scheme. Going forward, the decision is likely to be cited for the proposition that institutional investors and non-sophisticated investors are not necessarily "similarly-situated" claimants.

The entire decision is available here:

Claim Order by jmaglich1