Ponzi, Property, and Luck

• Author: Andrew Kull
• Position: Distinguished Senior Lecturer, University of Texas School of Law; Reporter, Restatement Third, Restitution and Unjust Enrichment
• Pages: 291-322

291

Ponzi, Property, and Luck

Andrew Kull

“Ignorance is the best of law reformers. People are glad to discuss a question

on general principles, when they have forgotten the special knowledge

necessary for technical reasoning.”

1

I. INTRODUCTION ............................................................................. 291

II. SPECIAL KNOWLEDGE: FIVE PROPOSITIONS .................................. 294

III. MOVING THE PROPERTY BASELINE ................................................ 298

A. OWNERSHIP OF IDENTIFIABLE PROPERTY .................................. 298

B. OWNERSHIP OF AN IDENTIFIABLE PRODUCT. .............................. 302

C. OWNERSHIP OF FUNDS WITHDRAWN FROM THE SCHEME ............ 306

IV. GENERAL PRINCIPLES .................................................................... 312

A. INCENTIVES ............................................................................. 313

B. LOSS SHARING ........................................................................ 315

C. LUCK AND BLAME ................................................................... 318

V. CONCLUSION: A THOUGHT EXPERIMENT ..................................... 320

I. INTRODUCTION

Swindler is running a Ponzi scheme. Two or more victims invest with

Swindler in the hope of turning a profit. The scheme eventually collapses.

Some residue of the victims’ investments is found in the ruins, and the

question is how to divide it between the victims. The basis of the division is a

claim in restitution or unjust enrichment that is now asserted, explicitly or

otherwise, by one fraud victim against another. Remedies in such cases are

 Distinguished Senior Lecturer, University of Texas School of Law; Reporter, Restatement

Third, Restitution and Unjust Enrichment. The encouragement of Ralph Brubaker, Ward Farnsworth,

Henry Smith, and Lionel Smith is gratefully acknowledged.

1. OLIVER WENDELL HOLMES, THE COMMON LAW 54 (1881).

292 IOWA LAW REVIEW [Vol. 100:291

predominantly equitable, and the question of allocation between victims is

sometimes described by comparing their “competing equities” or by asking

“what equity requires.” Courts have recently been giving new answers to this

old question. My topic is to ask why equity now seems to require something

different from what it required in the past.

The traditional answers came from the property-rights end of the equity

spectrum, the part that depends least on “equitable discretion.” But during

the second half of the 20th century, for a variety of reasons, the law of

equitable interests in property (as part of the law of restitution generally)

suffered a dramatic decline in professional attention and awareness—a story

that is old news by now.2 Propositions that were once part of what everyone

knew became doctrine that could only be found in the library, and then only

if one knew where to look. While this law was being forgotten, United States

courts were encountering an extraordinary upsurge in Ponzi-type cases.3 As it

happened, these cases fell to be litigated and decided by a new group of

American lawyers and judges: the first professional generation—roughly

speaking, of course—to attend law school after the courses dealing with

equitable interests in property had been dropped from the standard

curriculum.

Lack of awareness of the established rules has given courts an unusual

freedom to decide for themselves and afresh what equity requires between

victims of a common fraud. In three recurrent settings—all of them familiar

locations within the landscape where exploded Ponzi schemes fall to Earth—

recent decisions reach outcomes different from those that traditional

authority would dictate. Ignorance has not produced a random

redistribution, because the new results in victim v. victim cases have all been

pushed in the same direction. Courts spread losses more widely by refusing to

recognize the effects of fortuitous circumstances—luck—that by standard

property rules would occasionally permit a few relatively fortunate victims to

lose proportionately less than others. The move has been away from a view

that takes victims as it finds them, toward one that seeks to rationalize and to

equalize, so far as possible, the consequences of a casualty to which multiple

victims are thought to have been uniformly subject.

This shift in outcomes has redrawn the established map of property rights

by shortening the reach of legally protected ownership. By traditional rules,

2. See, e.g., Douglas Laycock, How Remedies Became a Field: A History, 27 REV. LITIG. 161, 173–74

(2008) (“As the [20th] century wore on, equity casebooks focused more on equitable remedies and

less on substantive equity.”). See generally John H. Langbein, The Later History of Restitution, in

RESTITUTION: PAST, PRESENT, AND FUTURE 57 (W.R. Cornish et al. eds., 1998); Andrew Kull,

Rationalizing Restitution, 83 CALIF. L. REV. 1191 (1995).

3. Anyone who reads the newspapers will share this impression, though I am not aware of

actual statistics. As a crude proxy, Westlaw reports that the name “Ponzi” appeared in 535 state

and federal decisions during the first 65 years of Charles Ponzi’s notoriety—or before January 1,

1985—and in approximately ten times as many since then. Decisions referring to “Ponzi” have

recently been added to the list at a rate of more than 600 per year.

2014] PONZI, PROPERTY, AND LUCK 293

the owner of an asset lost to fraud can retake it so long as it can be identified—

unless and until it comes into the hands of a bona fide purchaser. Protected

ownership thus extends beyond a misappropriation, ending only when

(1) the misappropriated asset can no longer be identified or (2) the rights of

a protected purchaser intervene. Because they deny the owner’s usual right

to restitution in such circumstances, recent decisions terminate ownership

earlier: at the point where the asset first leaves the owner’s hands.

Most of the recent victim v. victim decisions do not see the problem in

property terms. If they do, they assert—in the name of “equitable

discretion”—an overriding authority to reallocate whatever entitlements

might exist.4 More commonly, the courts—and the receivers whose rulings

the courts approve—see themselves as writing on a blank slate, subject to a

single guideline: a duty to divide contested property in whatever manner

seems best under the circumstances.5

My intention is not to criticize the courts for ignoring the rules.6 My

proposition is rather that the new outcomes in victim v. victim restitution cases

make a striking instance of Holmes’ law reform by ignorance. If we observe

that some “special knowledge” has evidently been forgotten, and that old

questions are being decided instead on “general principles”—and coming out

4. See, e.g., SEC v. Credit Bancorp, Ltd., 290 F.3d 80, 88 (2d Cir. 2002) (finding that the

existence of a constructive trust at state law “does not defeat the equitable authority of the District

Court to treat all the fraud victims alike (in proportion to their investments) and order a pro rata

distribution”); United States v. Vanguard Inv. Co., 6 F.3d 222, 226 (4th Cir. 1993) (finding

entitlement to restitution at state law, assuming it exists, may be disregarded by a court exercising

its “discretionary power” of equitable receivership). Invoked in this way, the asserted discretion

to reallocate state-law entitlements in the context of a federal receivership strongly resembles the

“free-wheeling equitable discretion to cut down entitlements when they are sought to be enforced

in a bankruptcy proceeding”—a discretion that does not exist:

Bankruptcy is an equitable procedure, and “equality is equity” (and vice versa), as

numerous bankruptcy cases intone. These truisms have a particular appeal for those

bankruptcy judges who would like to administer the bankruptcy laws in accordance

with their personal notions of fairness. But it is now well settled that although the

origins, procedures, and many of the remedies of bankruptcy a re indeed equitable,

a bankruptcy judge has no authority to cut down the entitlements that creditors seek

to enforce in bankruptcy, except as provided by the Bankruptcy Code itself.

In re Stoecker, 179 F.3d 546, 551 (7th Cir. 1999) (Posner, C.J.) (citations omitted). If the idea

of the present discussion were to criticize the recent Ponzi cases on the ground that they were

incorrectly decided, a good way to start would be to demonstrate that a federal equity receiver

has no more power to cut down state-law property entitlements than does a bankr uptcy judge.

My present purpose is different, as I am about to explain.

5. “There are no hard rules governing a district court’s decisions in matters like these. The

standard is whether a distribution is equitable and fair in the eyes of a reasonable judge.” SE C v.

Enter. Trust Co., No. 08 C 1260, 2008 WL 4534154, at *3 (N.D. Ill. Oct. 7, 2008).

6. For criticism along these mor e traditional lines see, for example, RESTATEMENT (THIRD)

OF RESTITUTION & UNJUST ENRICHMENT § 59 & cmt. g and accompanying Reporter’s Note

(2011); Chaim Saiman, Restitution and the Production of Legal Doctrine, 65 WASH. & LEE L. REV. 993,

998 (2008).