Were the Mayfair 101 investment schemes Ponzi schemes?

Were the Mayfair 101 schemes only investment businesses that failed or were they fraudulent operations like a Ponzi scheme?

The Federal Court of Australia has answered this question in a decision examined in this article.
But first, let us examine the characteristics of a Ponzi scheme.

A Ponzi scheme

A Ponzi scheme is fraudulent. This is the definition of a Ponzi scheme in the Oxford Dictionary of Economics (5th edition, 2017):

[A “Ponzi scheme” is a] fraudulent investment scheme that pays a return to current investors using their own investment or funds from subsequent investors. A Ponzi scheme attracts investors by promising returns that are high relative to alternative investments. The promised returns can only be paid if the flow of new investment is sufficiently great. Since this cannot be sustained in the long run a Ponzi scheme must inevitably collapse …

These are three examples:

Charles Ponzi in Boston in the 1920s promised investors that their funds were invested in international mail coupons yielding 50% interest in 90 days.

Bernie Madoff in New York in the 1980s and 1990s promised investors that their funds were invested in financial instruments and securities which yielded a steady, reliable return of 10% to 12%.

Melissa Caddick in Sydney in the 2010s promised ‘dazzling’ investment returns from financial instruments and securities.

What happened to the funds? In all three examples, investor funds were not invested. They were used to pay returns to investors and were spent on lifestyle and acquiring properties.

The Mayfair 101 investment schemes

The Federal Court of Australia summarised the Mayfair 101 investment schemes in Australian Securities and Investments Commission v Mayfair Wealth Partners Pty Ltd (No 2) [2021] FCA 247 (23 March 2021) (Anderson J), as follows:

• Mayfair 101 investment schemes raised $210 million from investors until 16 April 2020 when the Court ordered a stop to advertising.

Investors were promised that:

• The funds were to be invested in debenture products paying a relatively high fixed rate of interest which were ‘comparable to, and of similar risk profile to, bank deposits’;
• he principal investment would be ‘repaid in full on maturity’ and the investment ‘carried no risk of default’; and
• The funds were to be invested in a ‘fully secured, asset backed investment product’ with ‘first-ranking, unencumbered asset security’.

In fact, the investments were:

• Made in illiquid and/or for the most part, non-income producing assets. For example, the funds raised on the ‘Core Notes’ products were used to purchase Dunk Island and a whole host of non-income producing properties (vacant land) in the Mission Beach region of Queensland; and
• Not fully secured because the security trustee of the Core Notes had security which was encumbered by prior first registered mortgages including mortgages to Naplend Pty Ltd to secure a short-term loan at an interest rate of 24% per annum.

In their report, the provisional liquidators of Mayfair 101 stated: “M101 has been insolvent since inception’ and ‘the realizable value of the assets are nil”.

For a detailed analysis, see my article From Dunk to Junk: Mayfair 101 promised investors secure income, left them with worthless debentures

Were the Mayfair 101 investment schemes Ponzi schemes?

The Federal Court of Australia recently considered this question in the decision of Australian Securities and Investments Commission v M101 Nominees Pty Ltd (No 3) [2021] FCA 354 (19 April 2021) (Anderson J).

ASIC’s submissions were that the activities of the Mayfair 101 Group were “Ponzi-like”

ASIC submitted that the Mayfair 101 scheme contained the usual Ponzi scheme factors: high investment returns with little risk, the use of new investor funds to pay returns to old investors, and the fraudulent diversion of investment funds for personal use.

But to succeed, ASIC needed to convince the Court that it was not an essential element of a Ponzi scheme that the investments were fictitious, because in the case of Mayfair 101, substantial amounts of the funds were invested in real estate.

ASIC cited a publication of the US Securities and Exchange Commission, which discusses Ponzi schemes:

A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi schemes are named after Charles Ponzi. In the 1920s, Ponzi promised investors a 50% return within a few months for what he claimed was an investment in international mail coupons. Ponzi used funds from new investors to pay fake “returns” to earlier investors.

Ponzi scheme organizers often promise high returns with little or no risk. Instead, they use money from new investors to pay earlier investors and may steal some of the money for themselves.

With little or no legitimate earnings, Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse[.]

(Citing https://www.investor.gov/introduction-investing/investing-basics/glossary/ponzi-schemes ) [judgment, paragraph 282]

ASIC also referred to the definition of a Ponzi scheme in the Oxford Dictionary of Economics (5th edition, 2017) – reproduced above. [judgment, paragraph 280]

ASIC submitted that ‘the fundamental problem with the schemes implemented by Mr Mawhinney is that they relied upon new investments to make payments due to existing investors’ which was ‘not disclosed to investors’. [judgment, paragraph 303]

ASIC explained that this was the case because the business model of the investment scheme did not have adequate funds at hand with which to pay existing investors.

In support, ASIC submitted these findings in the Provisional Liquidators’ Report:

[T]he business model of [M101 Nominees] was not sustainable. This is on the basis that [Core Notes] noteholders were investing predominantly for periods of 6 or 12 months, however the loan agreement with Eleuthera had a term of 10 years. On this basis, [M101 Nominees] would not have adequate funds to repay any contributions as they fell due and as such [M101 Nominees] has been insolvent since inception and remains insolvent as at the date of this report.

[D]istributions and redemptions paid to [Core Notes] noteholders were funded out of funds raised from other [Core Notes] noteholders or to a lesser extent M+ [Notes] noteholders. There was a high level of frequency of fund transfers between [M101 Nominees] and Eleuthera which has masked the extent of this issue. [judgment, paragraph 283]

James Mawhinney’s submissions that Mayfair 101 schemes were not a Ponzi scheme

James Mawhinney was the ‘directing mind and will’ of Mayfair 101 / M101 Nominees (and its ultimate beneficiary).

He submitted that ASIC’s description of Mayfair 101 as a Ponzi scheme was ‘fundamentally wrong’ because it is ‘crucial to the definition of a Ponzi scheme ... that it is a fraudulent investment operation which has zero chance of success’.

He submitted that Mayfair 101 had made investments. He pointed to the fact that the Mayfair 101 Group had purchased and settled 119 real property assets in and around Mission Beach and Dunk Island in Queensland and had paid deposits on a further 111 properties.

He further submitted that ‘whilst interest payments were made to investors in part using funds deposited by new investors, the ability of M101 Nominees to do so’ was adequately and properly disclosed to investors as permitted for ‘capital management purposes’ in the brochures. [judgment, paragraphs 249 to 254]

Finally his counsel submitted that ‘Mr Mawhinney set up an investment business that failed because it bought too many assets quickly and then took on a bad loan to meet settlement obligations’, and was not a Ponzi scheme. [judgment, paragraph 362]

The Court decides

The Court needed to find that “Mr Mawhinney personally benefitted or stands to personally benefit” from the Mayfair 101 investment schemes. [judgment, paragraph 55]

If so, and if he was the author of the misleading and deceptive conducts of Mayfair 101, the conduct being ‘Ponzi-like’, then the Court would restrain Mr Mawhinney from engaging in similar activities in relation to financial products.

The Court agreed with ASIC that the Mayfair 101 investment schemes were Ponzi-like schemes for these reasons:

“I find [Mr Mawhinney’s] submissions unpersuasive for two reasons.

First, again, these matters were never disclosed to Core Notes investors. Core Notes investors were never told that the Core Notes investment proposal was to acquire “property at the rate of knots, bringing in money at a very fast rate, but acquiring properties even faster” and that, as a result, a loan with a very large rate of interest would be, or might be, entered. That loan was described as “one of the worst loans you could ever imagine”.

Second, there is no evidence which could provide an adequate answer to the critical question posed by Mr Mawhinney’s Counsel, namely: how could any business that has no or very little income hope to satisfy the interest obligations owed to Naplend Pty Limited and Core Notes investors unless it acquired funds from new investors putting money in? Separately, why was that position not explained to Core Notes investors?

Mr Mawhinney has tendered no evidence about those issues. They are critical issues that Mr Mawhinney failed to adequately address.

As ASIC submitted, there is no evidence as to why Mr Mawhinney permitted the Naplend Pty Limited loan to be entered into, or how and why he had placed the relevant companies in such a desperate financial situation that they were reliant on lenders such as Naplend Pty Limited. In these circumstances, ASIC’s submission that the Core Notes scheme was inherently problematic and fatally flawed must be accepted. In this respect, ASIC’s submission is relevantly supported by both Mr Tracy’s Expert Opinion and the Provisional Liquidators’ Report.” [judgment, paragraphs 363 & 364]

The Court came to the conclusion that the Mayfair 101 schemes were Ponzi schemes, even though some investor funds were invested in real assets. The Court observed that such investments were not disclosed to investors, were not appropriate because they were illiquid, and became worthless because the high interest rate on the short-term funding ‘absorbed’ all the funds invested.

The Court considered that the crucial element of a Ponzi scheme that was satisfied was the use of money from new investors to satisfy obligations to early investors and lenders, resulting from an unsustainable business model.

As a consequence, the Court ordered that Mr Mawhinney be restrained from being engaged in soliciting funds, receiving funds, advertising, promoting or marketing any Financial Product of the kind that Mayfair 101 promoted for a period of 20 years.

ASIC did not make application for penal orders against Mr Mawhinney.

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