Alleged Ponzi Scheme Perpetrators Speak Out Against Use of Words “Ponzi Scheme”

Posted by Kathy Bazoian Phelps

   What is it with alleged Ponzi scheme perpetrators these days? They seem to have a heightened sensitivity to the use of the words "Ponzi scheme." In 2012, two cases were decided against two governmental agencies – the SEC and the IRS–in connection with their use of the words "Ponzi scheme."
In a case brought by the SEC against Small Business Capital Corp. and its principal, Mark Feathers, Feathers filed a Motion for Restraining Order ("TRO"), Preliminary Injunction, Sanctions, and Special Damages against the SEC, arguing that the SEC used "fighting words" in certain publications related to the case. SEC v. Small Business Capital Corp., 2012 U.S. Dist. LEXIS 178392 (N.D. Cal 2012). Feathers based his motion on the argument that the SEC’s use of the works "Ponzi-like" and "swindler" are "fighting words" which violated that his First Amendment rights. The court, in denying Feathers’ motion, noted:
The problem with Plaintiff's request in the context of this action, however, is that claims under the First Amendment are not at issue in this case. Indeed, the classic issue presented by "fighting words" is whether such speech is constitutionally protected; in other words, whether the challenged speech is "likely to produce a clear and present danger of a serious substantive evil that rises far above public inconvenience, annoyance, or unrest." City of Houston v. Hill, 482 U.S. 451, 462 (1987). Any party's right to free speech is not implicated by the claims brought by Plaintiff, which involves only violations of securities law. Absent such a free speech issue, the court is unable to analyze whether Defendant could prevail on the merits of a First Amendment claim.   The court found that "fighting words" lose First Amendment protection only if they constitute "words that by their very utterance inflict injury or tend to incite an immediate breach of the peace." Id. at *5 (citing Hill, 482 U.S. at 461-62). After denying Feathers’ request for a TRO and preliminary injunction, the court cautioned:
With that said, however, the court expects all parties to this case to act in a dignified and appropriate manner. The language utilized in press releases, pleadings or other documents should be carefully chosen so as not to denigrate others or unnecessarily jeopardize the viability of the investment assets, especially when this case remains at the initial stages of litigation.Id. at *6.
   In a separate case brought against the IRS, Plaintiffs Emerging Money Corporation, Emerging Administrative Services, LLC and Emerging Actuarial Designs, LLC alleged that the IRS had wrongfully disclosed information when it asserted to certain taxpayers that the transactions that the "Plaintiffs had promoted to them were ‘sham transactions’ and part of a ‘Ponzi scheme.’" Emerging Money Corp. v. United States, 873 F. Supp. 2d 451 (D. Conn. June 4, 2012).

   The Plaintiffs’ "claim was based on 26 U.S.C. § 7431, which permits plaintiffs to recover damages when an officer of the United States knowingly or negligently discloses returns or return information in violation of Section 6103. Plaintiffs seek, inter alia, $1,000 for each unauthorized disclosure of their return information." Id. at *6. The IRS filed a motion for summary judgment, arguing that it was permitted to make those statements under the Internal Revenue Code.

   The facts in the case were that the IRS had investigated the Plaintiffs’ "Stock to Cash" program in which a client would transfer shares of stock to a lender and the lender would make an upfront cash payment called a "loan." The IRS concluded that the program was a Ponzi scheme and delivered letters to the clients who had participated in the program which included the following information: "(1) identification of Plaintiffs as possible ‘lenders’ or administrators of the Stock to Cash program (the ‘identification of Plaintiffs’); (2) the statement that the IRS was conducting an investigation of the Stock to Cash program (the ‘investigation assertion’); (3) the IRS's position that the Stock to Cash transactions were ‘sham transactions’ (the ‘sham-transaction assertion’) and (4) the assertion that those transactions were ‘built into a Ponzi scheme’ (the ‘Ponzi-scheme assertion’)." Id. at *4-5.

   The IRS contended that it was entitled to disclose the information under the "Own Information" exception under 26 U.S.C. § 6103(e)(7). The court reviewed relevant case law and concluded that most of the information disclosed was the recipients’ own information because it "consisted of facts that directly impacted the Recipients' tax liabilities." However, the court noted, "But the Ponzi-scheme assertion did not directly impact the Recipients' tax liabilities. Their ‘loans’ would have been considered sales of stock whether or not the program was a Ponzi scheme. The fact that the transactions were ‘shams’ was enough to establish to the Recipients that they were invalid, without a contextual reference to a larger Ponzi scheme." Id. at *13.

   The court reviewed several other exceptions, such as the "Administrative Proceeding" Exception, the "Investigative Purposes" exception, and the "Erroneous Information" issue, and ultimately concluded that the IRS did not violate Section 6103 when it sent out the letters regarding most of the information contained in the letters. However, the court found that the "exceptions did not cover the IRS’s assertion that the Stock to Cash program was a Ponzi scheme." Id. at *23. The court instructed the Plaintiffs to file a statement and explanation of the damages they were seeking if they wanted to proceed to trial. The Plaintiffs filed a supplemental statement asking for $69,000 in statutory damages, or in the alternative, actual and punitive damages, plus attorneys’ fees and costs. The Plaintiffs’ statement is attached here.

   Two alleged Ponzi scheme perpetrators, two governmental agencies, two courts, and two decisions – all involving the use of the words "Ponzi scheme." If nothing else, these cases are a reminder that we are in this country innocent until proven guilty, so we should tread carefully when using those two little words.