In a 2/1 opinion, the Ninth Circuit reaffirmed adherence to the so-called Ponzi scheme presumption. Over a dissent, the majority held there is a presumption of fraudulent intent if the trier of fact concludes there was a Ponzi scheme.

Although perpetrators of Ponzi schemes will never confess, the dissenter would have required the trustee to produce evidence about fraudulent intent and would have instructed the jury to decide whether the fraudster had fraudulent intent. In other words, the dissenter was not willing to presume fraudulent intent in all cases where there is shown to be a Ponzi scheme.

The debtor was the perpetrator of a Ponzi scheme that collapsed in 2009, about the same time that Bernie Madoff’s fraud exploded into the headlines. The debtor in the Ninth Circuit appeal ended up in chapter 7, while Madoff was being liquidated under the Securities Investor Protection Act, a distinction without a difference.

The trustee sued an individual for receipt of fraudulent transfers with “actual intent” under Section 548(a)(1)(A). The defendant had never filed a proof of claim, so the reference was withdrawn. After a six-day trial, the jury in district court held the defendant liable for receipt of actually fraudulent transfers as part of a Ponzi scheme. The defendant appealed to the Ninth Circuit.

The Jury Instructions

As Circuit Judge Gabriel P. Sanchez said for himself and District Judge Edward R. Korman, sitting by designation, the district court’s instructions to the jury defined a Ponzi scheme, among other things, as a financial fraud that gives investors the impression of being a legitimate, profitable business. The jury instructions said that the “hallmark” of a Ponzi scheme is using money from later investors to pay earlier investors.

The jury was told that proving the existence of a Ponzi scheme establishes actual intent to defraud, but the jury was not asked to decide whether the fraudster had actual intent to defraud.

Judge Sanchez said that the “district court’s jury instruction track[ed], almost verbatim, how this Circuit has defined a Ponzi scheme for over thirty years.” “By definition,” he said, “a Ponzi scheme is destined to fail because the pool of available investors is not limitless.”

Once the trustee proves the existence of a Ponzi scheme, Judge Sanchez said that “the trustee is entitled to the irrebuttable presumption that the debtor transferred money with actual fraudulent intent under section 548.”

Intent Is Presumed

On appeal, the defendant argued that the jury instructions were erroneous because there was no requirement to find that the fraudster had mens rea or fraudulent intent. The defendant believed that the jury should have been instructed to decide whether the fraudster knew that the scheme would “eventually collapse.”

Judge Sanchez said that he was “unaware of any court decision that has adopted an express mens rea requirement when defining a Ponzi scheme in a civil or bankruptcy action to avoid a fraudulent conveyance, and for good reason,” because trustees “are unlikely to find direct evidence of the operator’s subjective intent to operate a Ponzi scheme.”

By proving there was a Ponzi scheme, Judge Sanchez said, “the operator’s actual intent to defraud his investors and knowledge that the scheme will eventually fail follows logically and necessarily.” He therefore held, “No further mens rea instruction was required as a matter of law.”

Judge Sanchez upheld the finding of Ponzi scheme with actual intent to defraud.

The Dissent

Circuit Judge Richard R. Clifton dissented, “respectfully.” He said that a finding of fraud “requires” a finding of actual intent and noted that the jury was not required to find that the fraudster acted with “an intent to defraud.”

On the facts of the case, where the fraudster had some legitimate business activities, Judge Clifton believed that “a finding of intent to defraud was not inevitable and cannot be presumed.” For him, it was “far from obvious . . . that [the fraudster] actually knew or intended to run what is understood as a Ponzi scheme.” [Note: Bernie Madoff conducted some legitimate business, although Judge Clifton believed that there were none in the case of Madoff. Arguments based on Madoff’s legitimate business led some defendants to contend, unsuccessfully, that the Ponzi scheme presumption should not have applied.]

Judge Clifton cited cases about the so-called Ponzi scheme presumption, where actual intent to defraud is “inferred” from “the mere existence of a Ponzi scheme.” He said it “may be appropriate” for a sophisticated fact-finder, like a bankruptcy judge, to apply the presumption because a bankruptcy judge would know that intent is an element of fraud.

On the other hand, Judge Clifton said that the jury was “not adequately instructed” because the jury “did not know that intent was an element of fraud.” He said that “wrongful intent can be inferred from circumstantial evidence. But at some point, the jury must be required to find fraudulent intent.”

Judge Clifton would have vacated the lower court’s judgment. He explained how the jury could make the finding of fraudulent intent:

Evidence that [the fraudster] continued to take money in from new investors while using it to pay out existing obligations could be sufficient to permit the jury to infer that he acted with fraudulent intent. A confession from the promoter is not required.