Locke Lord QuickStudy: “Ponzi Scheme” Recital Not Enough

In a recent example, Patek v. Alfaro (In re Primera Energy, LLC), No. 15-51396-CAG, Adv. No. 15-05047-CAG, 2016 WL 5485120 (Bankr. W.D. Tex. Sept. 29, 2016), investors sued several oil and gas companies, and the companies’ principals, claiming the defendants defrauded them out of millions of dollars.  The investors claimed the defendants were operating a Ponzi scheme.  More specifically, they alleged that their investments were made for a specific well, but that their money was used instead to pay the operating costs, expenses, and vendors for different wells.  The investors claimed they were entitled to damages for: common-law fraud and negligent misrepresentation; violations of the Texas Uniform Fraudulent Transfer Act; fraud in a real estate transaction under the Texas Business and Commerce Code; common-law breach of fiduciary duty; violations of the Texas Deceptive Trade Practices Act; common-law conversion; common-law money had and received; common-law unjust enrichment; violations of the Texas Securities Act; and common-law conspiracy.

The defendants sought dismissal.

The court began its analysis by defining a Ponzi scheme as a “fraudulent investment scheme in which money contributed by later investors generates artificially high dividends or returns for the original investors, whose example attracts even larger investments.” Patek, 2016 WL 5485120, at *4 (citing Janvey v. Alguire, 647 F.3d 585, 597 (5th Cir. 2011) and quoting Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1088 n.3 (2d Cir. 1995) (“A [P]onzi scheme is a scheme whereby a corporation operates and continues to operate at a loss. The corporation gives the appearance of being profitable by obtaining new investors and using those investments to pay for the high premiums promised to earlier investors. The effect of such a scheme is to put the corporation farther and farther into debt by incurring more and more liability and to give the corporation the false appearance of profitability in order to obtain new investors.”)).

The court then held that a plaintiff who pleads facts supporting a conclusion that the defendant operated a Ponzi-scheme could then use a “Ponzi scheme presumption.”  Id. at *3–4.  In other words, the plaintiff must allege the defendant used later-invested money to pay or generate artificially high dividends or returns for earlier investors.  Id.  The “Ponzi scheme presumption” then replaces allegations otherwise necessary to support a conclusion of fraudulent intent in instances where fraudulent intent is an element of one of the plaintiff’s pleaded causes of action.  Id.  Doing so simplifies the plaintiff’s pleading requirements in the face of a motion to dismiss.

In Patek, the investors responded to the companies’ motion to dismiss by seeking to invoke the benefit of the “Ponzi scheme presumption.”  The court, in analyzing whether the investors had properly pleaded the existence of a Ponzi scheme, examined the facts that the investors alleged.  “Plaintiffs make numerous and detailed allegations that Defendants procured investments from investors which were used to fund Mr. Alfaro’s lifestyle and the expenses incurred on previous wells.  That is, Plaintiffs have alleged that investments made for a specific well were used to pay the operating costs, expenses, and vendors for wells other than the well which the investment was designated to benefit.”  Id. at *4.   See id. at *3–4.  The court held this alone was insufficient.  The court held the investors could not invoke the “Ponzi scheme presumption,” as the complaint “barely mentions the existence of any dividends or returns being paid to investors at all—from later-procured investments or otherwise.”  Id.

The court went on to analyze the investors’ eleven causes of action, without giving the investors the benefit of the “Ponzi scheme presumption.”  The court granted in part and denied in part the motion to dismiss.  Id. at *4–15.