Do governments have an obligation to crack down on Ponzi schemes? A group of Latin American investors seems to think so.

Readers may remember the case of R. Allen Stanford,  a Texas financier found guilty last year of orchestrating a $7 billion Ponzi scheme. Through offshore accounts and the buying of political influence in tax haven countries, he was able to seduce retirees and investors around the world with the promise of higher-than-market returns.

In a series of filings from December 2012, nationals of Uruguay, Peru, Chile and various Central American countries who invested in Stanford’s group charge U.S. securities regulators of negligence in not investigating the Ponzi operator sooner. These investors claim that the U.S. has a positive obligation under international law to shut down and investigate Ponzi schemes in a timely manner. They point to supposedly ignored complaints made to the SEC by non-U.S. nationals over 1997-2009 as evidence for a pattern of disregard and discrimination. They’re demanding over $40 million total in compensation.

This is an interesting case, brought by the ever-creative Todd Weiler, a Canadian trade attorney who runs a site related to investment treaty disputes under NAFTA.

A few things jump out at me from a quick gander at the filings:

  1. It is one thing to argue that specific actions that a state took can violate international treaties. But is a failure to pop a Ponzi scheme something that falls below the international minimum standard of justice, or a denial of full protection and security? This is what the investors claim. In the past, this full protection clause had more to do with state failure to protect foreign investors from the fallout of civil war. Arguably, all but the weakest states should be able to provide such minimal protection. But I have never seen an argument that a state has an obligation to be proactive at the highest levels of administrative law enforcement. Most countries would not have the regulatory apparatus to sort out such complex schemes, so it is unclear that state practice has actually established that anti-Ponzi regulation is part of the international legal floor. Or is this a special floor that corresponds only to the most sophisticated regulatory states?
  2. It is unclear why Weiler did not advise his clients to bring some of these  claims under the financial services chapters of the U.S. agreements with Peru and Chile and Central America. It seems that this type of financial flow would fall under the special law (lex specialis) represented by those chapters, not the more general law of the investment chapter. By the way, there are not as many protections for financial assets as for other types of investments, so the case might be weaker under the financial services chapters. It will be interesting to see which chapter the arbitral tribunals look to.
  3. Finally, since the deal with Chile has only been around since 2005, with Uruguay since 2006, the CAFTA since 2006-09, and with Peru since 2009, it is unclear that the alleged negligence and damage by U.S. authorities was caused during a relevant time frame. In other words, I doubt that a tribunal would have much if any temporal jurisdiction over the alleged wrongdoing.
  4. It is also unclear if these Latin American investors would have standing to use U.S. courts for this alleged negligence. I don’t believe that failure to regulate on xenophobic grounds would be actionable in U.S. courts. If I am right, this could be an instance of international treaties giving greater rights to Stanford’s foreign victims than to his U.S. victims.

All that said, this is a fascinating case. I’ve often argued that investment treaties could be used to chill the exercise of regulation. If the Weiler cases advance, states might be pressured into more effective regulation.

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