Private Investment Pools Dealt Blow : Finances: Judge rules there is no legal recourse to collect debts. Financing in minority communities could be affected.

In what could discourage underground loans in several of Los Angeles’ minority communities, a Los Angeles Superior Court judge has ruled that the private cash pools or financial groups among Korean-Americans called kyes are illegal lotteries and violate the state’s security laws.

Judge Edward M. Ross ruled this week that organizers have no legal recourse in collecting debts from those who take part in such pools.

It is the first litigation affecting such pools, but the ruling will only be a binding legal precedent if it is upheld at the appellate level. Although this decision may not be appealed, some of those involved believe the results send an unsettling message to people struggling to obtain financing when the regular banking community will not help them.

At the same time, observers note that abuses in such pools threaten participants with the loss of their investments.

What are known as cundinas or tandas in the Latino community, tanamoshi in the Japanese-American community and “family investment teams” in the African-American community, often vary in details of operation from the Korean kye that Ross ruled was illegal.

But the principle is the same: A group of people each put up money, usually by the month, with one of them getting the full pot each time. Only when all have received their “distribution” is the group terminated. The “loans” are sometimes at a low interest rate or without an interest charge, and sometimes the organizers make a profit.

Trouble may arise if a party that has received a distribution during the early months stops paying later on.

“These private arrangements depend on mutual trust,” said Richard T. Griffin, the attorney representing Jung-Hie Park, the plaintiff who sought unsuccessfully to collect a $50,000 debt in Ross’ court from one of the participants. “If the courts say they are not legal, a vital underpinning of that trust is removed, since the arrangement will have no sanction in law.”

Ricardo Soares, law clerk to Tyson B. Park, the attorney for the defendants, said that although there may be “potential adverse economic ramifications” for economically deprived communities in the ruling, abuse in such private loan groups is so rampant that the judge’s decision is justified.

“The schemes can have devastating consequences to the participants,” Soares said. “If the founders skip town with the money, or decide to file for bankruptcy, then all the investors’ risk capital is lost.”

Cesar Noriega, an attorney with the Legal Aid Foundation of Los Angeles, said Ross’ decision makes him uneasy.

“By and large, these groups are a positive thing,” he said. “They force people who aren’t too disciplined into saving the money. In addition, they promote the members helping each other and getting to know each other.”

Of the Ross decision, Noriega said: “The people who sit down there (at the courthouse) and make these rulings are often very far removed from the common people.”

However, attorney Bub-Joo Lee , who has been representing Korean-American merchants against insurance companies who failed to pay riot claims, cautioned that the kye s “are traditionally very risky loan schemes” that may not work as well in the United States as they do in Korea, where there is “more social pressure for people to pay up.”

“The organizers here do try to weed out less trustworthy individuals,” he said. “But in Seoul, it’s harder to evade one’s payment responsibilities.”

Nonetheless, he added: “The fact that these institutions do persist here indicates their utility. . . . Maybe they do run afoul of state security laws, but maybe they serve useful functions. . . . The monthly gathering at which the payments and payouts are made takes place in a big restaurant, and the person who gets the pot for that month pays for dinner for all the members. Ideally, then, there’s enough social pressure so that the chances of default will be minimized.”

The monthly amounts collected vary, with many participants investing $250 a month or less. But in the Korean-American community, amounts running $100,000 or more a month are common.

The case brought before Ross involved a rather common complication in the process, in which organizers and even participants may be involved in more than one kye at a time.

The defendants, Young-Wan Song and Hyun-Sun Song, a married couple, had a relative in another kye who filed for bankruptcy and stopped making his monthly payments.

When the time came for a distribution to the Songs, the organizers, fearing that they too would file bankruptcy after getting their money, refused to make the payment to them unless the couple put up collateral guaranteeing future monthly contributions.

The Songs, noting that nothing had been said about collateral from other participants, refused to put it up, the distribution was withheld, and they stopped paying their monthly contribution. Organizer Jung-Hie Park sued to collect from the Songs.

In this kye , there were 31 members, and over the 30-month span of the group, there were to be 31 distributions of money, with 30 members paying each month and their payments forming a pot that went in its entirety to the person who was the recipient that month.

Each member started out contributing $3,334 a month, and after receiving their distribution, they were supposed to pay $3,334 each month until the group was terminated.

In the first three months the three organizers received, one by one, $100,000. For them, this constituted an interest-free loan, because their total payments would be $100,000.

But beginning with the fourth month, when the regular participants became eligible for the monthly distribution, a bidding process determined who would get the money. The participant who expressed willingness through his bid to take the least money was awarded the pot.

If, for example, the winning bidder for the fourth monthly distribution agreed to take $64,000, then the sum would be made up from the $3,334 payments owed by the organizers who had already received their distribution, a total of $10,000, and then $2,000 would be collected that month from each of the other 27 participants who had not yet received a distribution.

But because the winning bidder in the fourth round would be obligated to pay $3,334 a month for all the ensuing months, he would be paying $100,000 over the entire life of the kye to receive $64,000.

By the time the last participant got the distribution, the other members would all be contributing $3,334, and the last participant could bid $100,000 and get it. Such a participant would profit from the scheme because he would have paid less than $100,000 over the 30 months due to the bidders taking less than $100,000.

The bidding process customarily differs in some of the Latino cundinas and other ethnic groups. In some cases, participants bid according to what extra amounts they are willing to pay the organizers.

In a brief order, the judge said he found that “the operation and organization” of the kye before him “is in fact a lottery and as such is being operated illegally by the organizers.”