Bad Guys in Bankruptcy: Excluding Ponzi Schemes From the Stockbroker Safe Harbor

By: Samuel P. Rothschild


The Bankruptcy Code (“Code”) reflects tension between two important goals: minimizing systemic risk in the securities market and remedying securities fraud. To minimize the displacement in the securities market that a major bankruptcy in the industry can cause, the Code creates a safe harbor from avoidance actions that could otherwise claw back transfers completed prior to bankruptcy; this is known as the “stockbroker safe harbor.” To redress securities fraud, however, the Code exempts from the stockbroker safe harbor those avoidance actions brought to claw back fraudulent transfers completed prior to bankruptcy. But this exemption is incomplete such that the stockbroker safe harbor shelters fraudulent transfers made by a Ponzi scheme before a certain point in time. As a result, early investors in a Ponzi scheme retain “profits” at the expense of later investors, who rarely recover their principal investments. Courts have attempted to exclude Ponzi scheme transfers from the protection of the stockbroker safe harbor provision by narrowly interpreting its terms and by holding that Congress did not intend for the provision to apply to Ponzi scheme transfers. This Note argues that each of these judicial approaches is inadequate and suggests other methods of excluding Ponzi scheme transfers from the protection of the stockbroker safe harbor.


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