Published on:

Ponzi Schemes, Loss, and Credit Against Loss

In white-collar cases, loss drives the sentencing guidelines. If a person is convicted of a federal fraud charge, probably the single biggest legal issue that will matter to that person’s sentence is what the loss amount is.

By contrast, the biggest thing about the case that will matter is what judge the person draws. It’s better to have a great sentencing judge and a high loss amount than a low loss amount with a judge who sentences more aggressively.

But I digress.

money-choise-concept-1439274-m.jpgThe government’s view of most fraud cases, in my experience, benefits from the clarity of hindsight. After everything has fallen apart, it’s easy to see that, say, a person selling an investment vehicle was using a new investor’s funds to pay someone who is clamoring for his or her money back.

In hindsight, it’s easier to see a Ponzi scheme than it may be in the crush of the moment. Some people plan to run Ponzi schemes, others fall into them through circumstance. Such is the way of the world.

In any event, loss for a Ponzi scheme can be tricky. Generally, the loss amount under the sentencing guidelines is the amount of money that was reasonably foreseeable to be lost by the victims. And it’s what’s reasonably foreseeable for the person committing the crime.

Ok, fair enough. The trouble is with the “credit against loss” rule. The sentencing guidelines explain that when the person being sentenced has paid some money back before the authorities or the victims cottoned onto the scheme, that money should be deducted from the loss amount.

This makes sense. If my son steals $20 from my wallet, but feels bad and puts it back before I notice, he should get some credit for that.

What makes this tricky is with a Ponzi scheme. There, early investors are paid money to convince them that the enterprise is earning its rate of return. The money often comes from a later investor’s contribution, sure, but it’s still real money that goes into the pockets of the early investor.

Does that money – the money paid to early investors – get deducted from the loss amount?

That’s the question which was answered in the Sixth Circuit’s United States v. Snelling.

There, Snelling pled guilty to being involved in a Ponzi scheme. He and another guy ran two companies that promised a 10 to 15 percent return to investors annually. Folks signed up. The investors, though, were paid from money raised by new investors, not from actual return generated from these investments.

As an aside, I would think it must be tremendously stressful to run a Ponzi scheme. The continual hunt for new investors – which must accelerate over time – just can’t be a good way to live. But I digress.

Under Mr. Snelling’s investment, many of the early investors were paid their advertised return. If you add up the amount that everyone put it, it would equal around $9 million. A $9 million loss, for Mr. Snelling, put him at a sentencing guidelines range of 121-151 months.

If, though, you subtract what folks were paid back, it would only be a $5 million loss (or so), with a range of 92-121.

So, do you subtract what the early investors were paid during the course of the Ponzi scheme.

The Sixth Circuit’s answer? Yes. But only to the amount originally invested.

So, if Investor A puts in $100,000 and is paid $150,000 – you’d only deduct $100,000.

It’s good to know the Sixth Circuit will be creating work for forensic accountants.

It’s a technical opinion, but great reading for anyone facing a credit against loss issue.