South Florida has many attractive attributes: bright sun, beautiful beaches, tropical temperatures with warm breezes from the Atlantic Ocean, swaying palm trees, five star-cuisine, South Beach night life, and a diverse population drawn from all parts of the world. These attributes attract tourists desiring fun and relaxation as well as new residents seeking a fresh start. But South Florida’s charms also have historically attracted operators of fraudulent schemes.
According to The Miami New Times, victims of ponzi schemes in South Florida lost $5 billion during the years 2008 through 2013, second only to New York. Fifty-four fraudulent schemes were uncovered during the same period, second only to California. The presence of elderly retirees, foreign money and immigrant communities creates a fertile breeding ground for frauds, particularly ponzi schemes. From the large ponzi schemes, such as the Scott Rothstein fraud involving over $1 billion in losses from investments in supposed employment litigation settlements, to smaller ones, such as the $3.4 million Marguerite Martial Jean affinity fraud targeting the local Haitian-American Community, South Florida historically has set a dubious benchmark for ponzi frauds. Long before Bernie Madoff made the term “ponzi scheme” a household word, South Florida fraudsters were masters of the ponzi trade.
The inevitable collapse of a South Florida ponzi scheme is always followed by attempts to recover the victims’ losses. Receivers or bankruptcy trustees search for any assets traceable to the investors’ pilfered funds, but invariably there are little remaining. They also may attempt to reshuffle the deck to spread the losses more evenly among the defrauded, by suing the investors who received “profit” distributions from the proceeds of later victims’ investments. But while a Receiver or trustee may diminish the losses somewhat, meaningful recovery for victims often times is dependent upon litigation under the fraud provisions of the federal and state securities laws, usually by class actions directed against conspirators and others with collectable assets or insurance. While the SEC or the U.S. Attorney may enjoin or incarcerate the wrongdoers, they rarely-if ever-obtain meaningful restitution for the victims. True recovery of losses most often is dependent upon successful civil litigation. Over the past twenty-six years, however, the availability of the securities laws to effect restitution and recovery of ponzi scheme losses has been substantially diminished, both by Congress and the Supreme Court. For example, to address perceived abusive class action “strike-suits” brought by the Plaintiffs securities bar, Congress in 1995 enacted the Private Securities Litigation Reform Act. The PSLRA imposed significant pleading hurdles for Federal securities fraud cases, and limited discovery until those hurdles were satisfied.
When the Plaintiffs bar attempted to avoid the PSLRA by filing class actions under state securities and common laws, Congress responded by further limiting the availability of class actions through enactment of the Securities Litigation Uniform Standards Act, which requires that most class actions alleging misrepresentations made in connection with the sale of a security be brought in Federal court, under Federal law. SLUSA even requires courts to conduct a mandatory Rule 11 analysis for every securities claim asserted, in a naked effort to chill the assertion of such claims.
In addition to the statutory restrictions on securities fraud litigation imposed by Congress, the Supreme Court likewise has relentlessly limited the civil application of the fraud provisions of the securities laws, and particularly the use of the class action mechanism to enforce them. Between 2006 and 2011, the Supreme Court has issued an astounding eight seminal decisions defining and often limiting the civil reach of the Federal securities laws, often in the class action context. During this period, the Court has twice further limited the liability of aiders and abettors as well as other secondary actors and enablers of fraudulent schemes. The Court also has heightened pleading requirements and has precluded extraterritorial reach of securities laws. The Court likewise has made the use of the class action mechanism more difficult, requiring granular analysis of the merits of the underlying claims, at the certification stage, and blessing boilerplate waivers of the right to bring a class action in favor of arbitration. Rather than an important tool to enforce securities laws, class actions are now the limited exception rather than the rule.
The rationale for these congressional and judicial limitations and restrictions on civil application of the securities laws is to protect legitimate businesses from abusive litigation arising from fluctuations in the price of public company stocks. Little consideration appears to have been given to the use of such laws to recover losses from actual, garden variety fraudulent ponzi schemes. But these limitations indeed have had an adverse impact in the ponzi scheme area. For example, investors in Madoff feeder funds generally have been unsuccessful to date in pursuing class action litigation to recover their losses.
Now, the Supreme Court is considering whether to impose the death penalty upon securities fraud class actions. Recently, it entertained arguments in Halliburton Co. v. Erica P. John Fund, Inc. to overrule or recede from the “fraud on the market” presumption created in Basic, Inc. v. Levenson, 485 U.S. 224. (1988). Adoption of this argument will essentially end class action securities fraud claims.
To succeed on a securities fraud claim, Plaintiffs must prove that they relied upon the material misrepresentation or omission underlying the fraud. In Basic, the Supreme Court recognized that requiring each member of a class to prove reliance on the particular misrepresentation or omission would serve as an insurmountable barrier to class certification, because the determination of each individual’s reliance would predominate over the common issues. The Basic Court therefore adopted prevailing economic theory that the market price of a security reflects all publicly available information, including misrepresentations. The “fraud on the market” arising from public misrepresentations and material omissions is therefore presumed to have been relied upon by each investor. This rebuttable presumption is critical to the certification of a class action. In the ponzi scheme context, reliance upon the usual misrepresentations as to the legitimacy of the underlying business, and the supposed legitimate use of investor funds, is ordinarily unrebuttable.
Knowing that requiring individualized proof of reliance would decimate class action securities fraud cases, Defendants have attempted to chip away at the fraud on the market presumption. Those efforts thus far have failed. In two recent cases, Erica P. John Fund Inc. v. Halliburton Co. and Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court rejected proposed barriers to use of the fraud on the market presumption. In Halliburton, the Court unanimously rejected the notion that Plaintiffs must first prove loss causation in order to invoke the fraud on the market presumption. In Amgen, a 5-4 majority held that materiality of the alleged misrepresentation need not be addressed or proven at the class certification stage. While these cases appear to have preserved the fraud on the market doctrine, the Amgen minority signaled that given an opportunity, they would seriously consider reexamination and complete abandonment of it.
That opportunity has now arisen. The reexamination and the potential destruction of the ability of defrauded investors to band together in a class action is now squarely before the Court in another appeal, Halliburton Co. v. Erica P. John Fund, Inc. There, Halliburton argues that Basic was wrongfully decided and that the “fraud on the market” presumption should be abandoned by the Court. Alternatively, Halliburton argues that it should be given the right –at the class action certification stage – to rebut the presumption with evidence that the misrepresentation had no “price impact;” in other words, that the misrepresentation was not material enough to affect the price of the security.
Should the Court overrule Basic, and altogether abandon the “fraud on the market” presumption, the ability of defrauded investors – even investors in a ponzi scheme – to certify a class will effectively end. Should the Court instead create a “price impact” requirement at the class certification stage, however, certification of a class of ponzi scheme victims will ordinarily still be possible because misrepresentations as to the legitimacy of the underlying business and the use of investment proceeds invariably will have a “price impact”.
If the Court decides to eviscerate the class action tool by eliminating the “fraud on the market” presumption, and therefore require each defrauded investor to file a separate action and prove individual reliance, the business community likely will celebrate. But so will South Florida’s ponzi schemers. In most garden variety South Florida ponzi schemes, which often times are affinity frauds among members of a church, synagogue, family or other community, the victims will have lost most everything. Without resources to pay lawyers, or the ability to band together to make their collective claims large enough to attract experienced class securities lawyers willing to work on a contingency fee basis, many victims will simply be financially unable to recover their losses. In its effort to protect public companies and legitimate businesses in general, the Court appears to be overlooking the effect that its rulings is having on those for whom the fraud provisions of the securities laws were designed to protect. Should the Court ring the death knell on class action securities cases, the South Florida climate for ponzi schemers and other fraudsters will become better than ever.