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Friday, November 30, 2012

Judge Posner Discusses Methods of Allocating Recovered Assets in Ponzi Schemes

A recent 7th Circuit opinion authored by Judge Posner, SEC v. Huber (No. 12-1285, Nov. 29, 2012)Download SECvHuber.112912[1], explores two alternative methods for allocating recovered assets to investors in a Ponzi scheme, the net loss method generally used in bankruptcy and the rising tide method which the SEC-appointed receiver used in this case.  Judge Posner explains the differences clearly and concisely (using graphs!).

Assume three investors lose money in a Ponzi scheme.  Each invested $150,000.  A withdrew $60,000 before the scheme collapsed; B withdrew $30,000; C made no withdrawals, for total losses of $360,000.  Assume receiver has $60,000 to distribute.  Under the net loss method, each investor would receive one-sixth of his losses:  A gets $15,000; B gets $20,000; C gets $25,000.  As a result, A recovered a total of $75,000; B recovered a total of $50,000; and C recovered $25,000.

In contrast, under the rising tide method,  withdrawals are considered part of the distribution received by an investor and so are subtracted from the amount of receivership assets to which he would be entitled if there had been no withdrawals.  In this example, then, for the "tide" to raise B and C as close to A as possible, B has to recover $15,000 in receiver assets, and C has to recover the remaining $45,000, so that the division among the three investors is 60-45-45 under this method.  (See the charts for a more complete explanation.)  Rising tide appears to be the method most commonly used in receiverships.

Judge Posner goes on to discuss whether rising tide discourages or encourages withdrawals from Ponzi scheme and finds that the public policy in bringing about the swift collapse of Ponzi schemes does not support one method over the other.  He notes that the net loss approach may be attractive when under rising tide a large number of investors would receive nothing, but finds that is not the case before him.  He also notes possible inconsistencies between approaches in receiverships and bankruptcy proceedings, before concluding that the investors had not shown that the district court abused its discretion in approving the reciever's use of rising tide.   

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