Ponzi schemes are the subject of much discussion these days because of the Bernard Madoff scandal. Defrauded investors and their attorneys are actively searching for sources of potential recovery to recoup losses. Those who invested indirectly through investment firms and "fund-of-funds" probably have the best chance of recovery since they have solvent targets to hold responsible.
In a Ponzi scheme, early investors are paid with funds from later investors. Can these later investors recover funds paid to the earlier investors? In Cote v. Texcan Ventures II, the later investors asserted such a claim, relying on a constructive trust theory. This argument has some appeal, as it was the later investors' money that was used to pay the earlier investors.
Unfortunately for the later investors, the Dallas Court of Appeals rejected the constructive trust argument:
The trial court concluded appellees and appellants were equally situated as victims of West's scheme, appellees were not unjustly enriched by receiving the funds, and equity, in the form of a constructive trust, should not intervene in the dispute. Appellants contend the trial court erred in denying them relief because, as a matter of law, a constructive trust was imposed on the funds for appellants' benefit and, as beneficiaries, they are entitled to recover the funds from appellees. The issue is whether any constructive trust imposed on appellants' money due to West's wrongdoing remained in effect after the funds were transferred to appellees.
When property subject to a constructive trust is transferred, the recipient of the property takes title to the property subject to the trust if (1) the recipient does not give consideration for the property or (2) the recipient has notice of the existence of the trust at the time of the transfer . . . appellees, who each lost a significant amount of money due to West's fraudulent investment scheme, were not unjustly enriched when they received the funds from Kalb that they believed were a return on their investments with West.
Because appellees did not have notice of a constructive trust when they received the funds from Kalb and because appellees were not unjustly enriched by receiving the funds, any constructive trust imposed on the funds due to West's fraudulent investment scheme did not survive the transfer of the funds to appellees. The trial court correctly concluded equity should not intervene to impose a constructive trust on the funds appellees received. We affirm the trial court's judgment.
While Texas law does not support a constructive trust theory in the ponzi scheme context, an alternate method of recovery might be had by characterizing payments to the earlier investors as fraudulent transfers under the Uniform Fraudulent Transfer Act.Business litigation and fraud attorneys.