New Hampshire Will Use Taxpayer Funds To Compensate Victims of $33 Million Ponzi Scheme
““Number one, the economy is going well…This situation is something that never should have happened. The fact that we had the revenue coming in as it has, it is the due diligence of the state to take care of this.”
New Hampshire Senator Gary Daniels
Ten years after the man responsible for New Hampshire’s largest Ponzi scheme surrendered to serve a 15-year prison sentence, the New Hampshire state legislature has approved allocating $10 million of taxpayer dollars from the state’s budget to be used to compensate victims of that Ponzi scheme. Scott Farah, the former owner of Financial Resources Mortgage, Inc. (“FRM”), is currently serving the sentence that was handed down after he pleaded guilty to fleecing investors out of $33 million. His arrest, however, rocked the New Hampshire government and ultimately resulted in a report from the state’s top criminal prosecutor that pointed to a number of red flags that were not identified or were otherwise ignored by a number of state agencies responsible for regulating FRM. While this is at least the third attempt to find a solution to compensate victims for what some attribute to the state’s regulatory failings, this is the first time that taxpayer funds have been tapped to fund the anticipated compensation. The move is sure to be cheered by Farah’s victims, who have received little of their losses, but also raises questions as to whether states should use taxpayer funds to compensate victims of Ponzi schemes.
The Scheme
Farah operated FRM and advertised the company as a residential and commercial mortgage brokerage and lending business. Another company, C L and M, Inc. (“CLM”), was a purported commercial loan servicer that was owned by Donald Dodge and worked closely with FRM. Beginning in 2005, Farah and FRM raised money from investors who thought they were investing in loans that would be used to fund commercial real estate projects and other businesses. One of the main methods used to target prospective investors was the mailing of postcards to a list of private mortgage lenders that had been purchased from a commercial database company, with the postcards touting the promised high-interest annual returns ranging from 12% to 20%. Investors were not told that a number of the loans structured by Farah and FRM were defaulted on by the borrowers; instead, CLM - the servicer - would continue to pay out the promised interest out of commingled bank accounts containing investor funds. Investor funds were also used for a number of other unauthorized purposes, including paying returns to existing investors, paying personal expenses, and even donating money to a church owned and founded by Farah’s father.
Farah and Dodge were indicted in 2010. Farah pleaded guilty and received a 15-year sentence (which was higher than the 10-year sentence requested by prosecutors), while Dodge was sentenced to a six-year term. Notably, Farah was days away from being released in mid-2020 after successfully obtaining approval for an early release as part of the government’s home confinement push to alleviate prison overcrowding in the middle of the COVID-19 pandemic. However, after victims intervened and brought this to the attention of the U.S. Attorney’s Office in New Hampshire (which claimed it was unaware of the notoriety of Farah’s crime), the decision was reversed days before Farah’s scheduled release. Farah is now scheduled to be released from prison in October 2023.
The Aftermath
In the wake of Farah’s arrest, questions quickly arose as to whether state regulators overseeing FRM’s industry should have acted sooner on alleged red flags that would have uncovered the fraud. In May 2010, the New Hampshire Department of Justice issued a report that set forth a laundry list of complaints and red flags in the ten-year period preceding FRM’s collapse and ultimately concluded that the state’s Securities Bureau, Banking Department, and Department of Justice suffered critical lapses that allowed FRM’s fraud to continue for years after it had been brought to regulators’ attention.
In one excerpt, the report detailed a complaint filed with the Securities Bureau in March 2000 by an attorney alleging that FRM had misled his client about the risk and viability of her investment. That attorney specifically referenced the possibility that FRM was operating a Ponzi scheme. The Securities Bureau then waited sixteen months to initiate an administrative proceeding, after which a hearing was held in July 2003. After an unsupervised Securities Bureau hearing officer presided over the hearing, and despite a statutory obligation to issue a ruling within a specific period of time, the hearing officer apparently declined to issue an order after determining that FRM investors would be better off if FRM voluntarily offered to redeem their investments rather than FRM being ordered to redeem all investments pursuant to a state statute. The report went on to detail a number of other violations, including a number of complaints filed with the regulators against FRM, yet no action was ultimately taken for years.
Efforts to Compensate Victims
A 2016 law was passed that created the FRM Victims’ Fund, a charitable trust that would solicit private donations to be used to compensate victims. However, the Fund largely remained dormant until the 2021 legislative session where state legislators - buoyed by a strong economy and state balance sheet - decided to amend the law creating the Fund to provide that a total of $10 million of taxpayer dollars would be allocated from the state’s budget to compensate Farah’s victims. The allocation would consist of $5 million for the fiscal year ending in June 2022 and an additional $5 million for the fiscal year ending in June 2023. The law further provided that an attorney or administrator would be hired to review victim applications and decide on payments to victims. Although the statute provides that the individual will be entitled to compensation, it does not specify whether that compensation will come out of the appropriated funds.
On August 13, 2021, New Hampshire posted a job opening for the FRM Claims Administrator and set an August 31, 2021 application deadline. The position link is available here.
Moral Hazard? Or Moral Obligation?
The New Hampshire legislature’s efforts, while not unprecedented, are extremely rare and raise complicated questions about whether taxpayer funds should be diverted from other pressing public needs to compensate investors of financial crimes. As one state legislator remarked:
“It is not a fiscally prudent use of taxpayer dollars when we are facing a tremendous homelessness problem, families in danger of losing their homes, and underfunded schools,” Rosenwald said. “The last thing we should be prioritizing right now is funding a handout to a small group of investors with the public’s hard-earned money.”
The move also raises the question of whether the state’s willingness to compensate victims of a Ponzi scheme might serve as a “moral hazard” whereby investors making risky bets will see the government’s willingness to step in as an incentive to continue making the risky bets.
On the other side of the equation, the proponents of the move argue that the move is a miniscule percentage of the state’s $13.5 billion budget and is the fulfilment of a promise the state made many years ago.
The New Hampshire DOJ’s Report is below: