Efforts to recover lost funds from Ponzi schemes introduce new legal term to public: 'clawback'

Earlier this week, friends and relatives of self-styled Twin Cities investment guru Trevor Cook learned that money they made from his nearly $200 million Ponzi scheme is subject to something called "clawback."

The legal process of recovering profits from illegal activity is well established, but until the massive financial frauds of the last two years, most people probably never heard the term.

Even though prosecution of the biggest, splashiest crimes may be winding down, the process of sifting through the financial fallout — which promises to affect Minnesotans from all walks of life — has barely begun. Because that means you're likely to be hearing a lot more about clawback, MinnPost offers a brief primer.

Taking back illegal profits
When financial fraud triggers a bankruptcy — albeit the collapse of a sham business — the law allows the court-appointed bankruptcy receiver to hunt down and take — or claw — back profits from the illegal activity, even if the person who has the money played no part in the crime.

The receiver then distributes the money among the fraudster's victims, much as it would a bankrupt but legitimate debtor's unpaid creditors.

"It's always been a part of bankruptcy law that you could go and get something back," said Peter Henning, a law professor at Wayne State University and author of "White Collar Watch," part of the New York Times' DealBook blog. "But normally you didn't look much past the defendants and their bankrupt estates."

In April, Apple Valley resident Cook pleaded guilty to defrauding investors throughout the country of $190 million. Operating out of Minneapolis' Van Dusen mansion, Cook used a radio program called "Follow the Money" to publicize a phony foreign currency trading program.

It's unknown how many of the more than 1,000 investors discovered so far — most of whom never met the fraudster — made money investing with Cook. There's evidence that a few early investors withdrew both their principal and some earnings as early as 2008.

Some are said to have asked for their money back because they grew suspicious of Cook. If the court can prove any of the investors knew what was really going on, usually they can be forced to return not just their illicit profit but their original investment.

But because Ponzi schemes by definition use money from new investors to pay off earlier ones, many had no idea their gains were ill-gotten and will be surprised when the receiver calls. Partly, that's because few have heard of clawback.

"The term has come into existence over the last few years," said Henning. "It's just a way of taking money that was undeserved. You appear to have earned it, but you didn't."

Large-scale Ponzi schemes rarely seen
So how is it we commoners are just learning the term? The short answer is that until recently we had never seen such a large-scale Tom Petters or Bernie Madoff operation.

Before the big-time fraudsters of the last couple of years, Ponzi schemes were much quicker to collapse. "If you had said to me five years ago that we'd see frauds that lasted this long, I would not have believed it," said Henning.

Cook, Petters and their ilk were able to perpetrate their schemes for as long as they did largely because lots of people made money with them early on.

"That's why a lot of people poured money into Madoff," said Richard Painter, who teaches corporate and securities law at the University of Minnesota Law School. "Because other people were making money hand over fist with him."

Because there are literally thousands of victims and creditors involved in the high-profile cases, the process can take years.

In the Madoff case, receivers are looking to recover from investors who pulled their money out as early as 2002, six years before the supposed Hedge Fund wizard was arrested. Some of the most sophisticated victims go into hiding, while others file their own suits seeking to halt the process.

A similar drama is grinding on in federal Court in Minnesota, as receivers try to figure out where money from Tom Petters' $4.6 billion Ponzi scheme went, how much of it they can get back and where it should go.

Petters' victims range from elderly Twin Cities individuals who lost their retirement savings to giant investment concerns that in turn defrauded other sets of investors of billions. Federal courts have identified some $300 million they hope to recover, but have been deluged by lawsuits filed by investors and creditors challenging myriad details of the process.

"Clawbacks often involve some litigation," said Henning. "People don't like to give up their money, or they may argue [their earnings are] legitimate."

While the courts go through the tedious process of determining who owns what and how they got it, trustees typically "grab the low-hanging fruit first," Henning added — "the Lamborghinis and the yachts."

Or in Cook's case, $362,700 in cash and a collection of "Fabergé" eggs and purses turned over to FBI in April.

All of which raises the question: How much of what gets clawed back will ultimately be left to distribute to victims? Sometimes pennies on the dollar, if that.

"Unfortunately, a lot of these bankrupt estates can eat up an awful lot of resources," said Painter.

Clearer laws would help expedite the process, he said.

Just as common sense could help avoid new Ponzi schemes. "People ought to know it's completely unrealistic" that they can get into one of the financial pyramids and come out ahead," Painter concluded. "You're either going to lose everything or you're going to have to give back what you earned."

Beth Hawkins writes about criminal justice, schools and other topics.