Ponzi schemes generally involve promises of high returns by salespersons over short periods of time, but in reality, result in stealing from Peter to pay Paul. Because returns to investors in criminal ponzi schemes are often paid out of new investment monies from new investors, the scheme will ultimately fall apart when the new investors dry up, leaving all investors often holding a worthless investment. Stockbrokers, financial advisors, and their brokerage firms who sell ponzi scheme fraudulent investments may be found liable for selling unsuitable investments, securities fraud, sale of unregistered securities, failure to supervise, breaches of fiduciary duty, and other legal violations.
If you believe that you may have lost money in a ponzi scheme recommended by your financial advisor, you should contact one of our lawyers as soon as possible.
Many ponzi schemes are fraudulently sold claiming high returns with low risk, a virtual impossibility. In virtually all investments, high risk goes hand in hand with high returns.
FINRA registered securities brokerage firms are required to do due diligence on and approve all investments before their financial advisors can recommend and sell them to customers. For example, see FINRA Rule 2111’s supplementary material .05 which states:
“The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member’s or associated person’s familiarity with the security or investment strategy. A member’s or associated person’s reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.” (Emphasis added).
Unfortunately, financial advisors do not always comply with this requirement, and the lawyers of Greco & Greco have filed many FINRA arbitrations against securities firms whose advisors sold ponzi scheme investments to customers without disclosing the sales to their firm. The reason is typically clear – many ponzi schemes pay out large commissions to individuals who sell them to incentivize the sale.
Although most brokerage firms claim they are not legally responsible for the sale of a criminal ponzi scheme if their supervisors were not aware of the sale (sometimes referred to as “selling away” from the firm), this defense is typically without basis. Firms can and should be held responsible for the actions of their registered sales force, and knowledge by supervisors of the wrongdoing is irrelevant.
First, securities firms have duties to supervise their salespersons to ensure compliance with the securities laws. See FINRA Rule 3110: “Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Final responsibility for proper supervision shall rest with the member.”
A customer can demonstrate failures to supervise by a firm by a number of means. All firms are required to have compliance and supervisory manuals setting out the processes they are supposed to follow for supervision and detection of wrongful conduct. These processes and procedures can and should include inspections of offices and files, both announced and unannounced, review of correspondence and email, review and approval of sales materials, review of trading in accounts and unusual activity in accounts, contact with customers when red flags are triggered, and other means.
The fact that a financial advisor is an independent contractor versus being an employee, or is in a small satellite office as opposed to a large branch, is irrelevant. As stated by the NASD (the former name of FINRA) in Notice to Members 86-65 “Irrespective of an individual’s location or compensation arrangements, all associated persons are considered to be employees of the firm with which they are registered for purposes of compliance with NASD rules governing the conduct of registered persons and the supervisory responsibilities of the member. The fact that an associated person conducts business at a separate location or is compensated as an independent contractor does not alter the obligations of the individual and the firm to comply fully with all applicable regulatory requirements.”
However, even if the firm claims it properly supervised its broker, it can and should be held responsible for that broker’s wrongful acts. As follows are some examples from Virginia law, but most state laws often hold principals liable for the acts of their agents.
The Virginia Supreme Court has described the liability of a principal for its agents, even if the principal/firm is entirely innocent, in the case of Dudley v. Estate Life Ins. Co. of America, 220 Va. 343, 350, 257 S.E.2d 871 (1979):
“A principal who puts a servant or other agent in a position which enables the agent, while apparently acting within his authority, to commit a fraud upon third persons is subject to liability to such third persons for the fraud. Restatement (Second) of Agency § 261. Comment a. to § 261 reads as follows: The principal is subject to liability under the rule stated in this Section although he is entirely innocent, has received no benefit from the transaction, and, as stated in Section 262, although the agent acted solely for his own purposes. Liability is based upon the fact that the agent’s position facilitates the consummation of the fraud, in that from the point of view of the third person the transaction seems regular on its face and the agent appears to be acting in the ordinary course of the business confided to him.” (Emphasis added).
As noted by the Virginia Supreme Court, the brokerage firm is liable even if it is entirely innocent, even if it received no benefit, and even if the agent was acting for his/her own purposes. The liability is based on the position in which the firm places the agent, which allows the agent to commit a fraud on their customer. In other words, even if the advisor recommended and sold a ponzi scheme to his/her customer for his own purposes in violation of firm policies, the firm is still liable because it placed that advisor in a position of trust before the customer which led to the sale.
State Securities Acts are another powerful tool to hold securities firms liable for the fraudulent sale of ponzi schemes by their agents. The Virginia Securities Act, which is similar to most other state acts, provides for control person liability and further requires the payment of reasonable attorney’s fees and interest in addition to damages.
The provisions of the Act, specifically Va. Code §§ 13.1-502 and 13.1-522, make it unlawful for a) a person to sell a security without disclosing all material facts or misstating material facts, b) a person to give advice as to purchasing or selling securities while engaging in “any act, practice or course of business which operates or would operate as a fraud or deceit,” or c) a person to even “indirectly” be involved in the purchase or sale of a security and to “employ any device, scheme or artifice to defraud.” A customer may then seek to hold the firm liable under the “control person” liability section of the Act.
Greco & Greco’s lawyers have repeatedly been able to recover client monies lost in ponzi schemes over the years through settlements and FINRA arbitration awards in claims against the salespersons registered securities firms. If you have lost money as a result of similar wrongful acts of your broker and/or financial advisor, please contact Scott Greco for a free lawyer consultation and discussion of your case. Our Virginia securities fraud attorneys represent customers from all states across the country, and have decades of experience protecting the rights of customers, and holding securities firms responsible for the acts of their brokers.