In a recent opinion, the Fourth Circuit approved the use of the “rising tide” method for distributing assets to defrauded Ponzi scheme investors, as well as the use of a “collateral offset provision” in the distribution plan. CCWB Asset Invs., LLC v. Milligan, 112 F.4th 171 (4th Cir. 2024). The defendants in the case were Ponzi scheme operators who raised over $345 million by defrauding more than 230 different investors. The SEC brought suit against the defendants and a receiver was appointed to liquidate the defendants’ assets and formulate a plan for distribution to the defrauded investors. The receiver’s proposed plan had two notable features that were the subject of appeal and the Fourth Circuit’s opinion: the use of the “rising tide” method of calculating distributions and the inclusion of a “collateral offset provision.”
The Receiver proposed using the “rising tide” method of calculating distributions to claimants. Using the rising tide method, withdrawals of funds made by a claimant prior to the receivership are counted as part of the claimant’s compensation. The defendants’ liquidated assets are then allocated to bring the total compensation for each claimant to the highest level possible. This method distributes a greater percentage of receivership assets to claimants who lost a greater percentage of their initial investment. One group of appellants objected to the use of the rising tide method, arguing that the receiver should apply a “maximum balance” approach to calculating distributions. Using a maximum balance approach, withdrawn funds that are later reinvested into the Ponzi scheme are not credited as compensation for Ponzi scheme losses. These appellants argued that applying the rising tide method without using the maximum balance approach unfairly penalized investors who withdrew, then reinvested, their money.
The District Court approved the receiver’s proposed distribution plan over the objections. The court determined that applying the maximum balance approach would require tracing the flow of funds for each withdrawal and reinvestment, which would be administratively burdensome and risk “violating [the receiver’s] duty to avoid overly costly investigations” that benefit an individual claimant at the expense of the group. The Fourth Circuit upheld this determination, holding that the District Court did not abuse its discretion by rejecting the maximum balance approach as being “too costly and time consuming.”
The receiver’s distribution plan included a “collateral offset provision,” which treated any money that a claimant had recovered from third parties to compensate them for their Ponzi scheme losses as if it were a pre-receivership withdraw by subtracting it from that claimant’s distribution of receivership assets. While some creditors argued that a collateral offset provision would disincentivize claimants from seeking third party settlements, the District Court overruled this objection, stating that without the offset provision, claimants that received third-party settlements would receive a disproportionately higher recovery on their investment. The Fourth Circuit upheld the decision as being within the lower court’s discretion, writing that, because the receiver has finite assets to distribute, there is no problem with prioritizing claimants who obtained nothing from third-party settlements over those who obtained something.