You Can't Cheat an Honest Man - James Walsh [132]
This so-called “Credit Alliance test” usually requires some evidence of a “nexus between the [professionals] and the third parties to verify the [professionals’] knowledge of the third party’s reliance.”
The 1988 New York case Crossland Savings v. Rockwood Insurance Co. involved a bank that loaned money to a crook in large part because the crook’s lawyer wrote several opinion letters attesting— wrongly—to the crook’s financial viability.
After the scheme collapsed, the bank sued the lawyer’s professional liability insurance company. The insurance company didn’t want to pay; it argued that the circumstances didn’t meet the Credit Alliance test. The court agreed with the bank: “When a lawyer at the direction of her client prepares an opinion letter which is addressed to the third party [namely, the bank] or which expressly invites the third party’s reliance, she engages in a form of limited representation.”
Under such circumstances, the “opinion letters do not constitute advice to a client, but rather were written at the client’s express request for use by third parties.”
Misrepresentations and Omissions
Under Securities and Exchange Act Rule 10b-5, burned investors can go after lawyers and accountants, alleging liability for either “material misrepresentations” or “omitting to state a material fact necessary to render the statements made not misleading.”
The first of these charges, misrepresentation, is easy to articulate in legal theory but difficult to prove. A burned investor has to establish that the lawyer or accountant affirmatively stated something untrue about the scheme or its perps. Most professionals—even determinedly crooked ones—can manipulate language enough to avoid this direct connection.
This is why the prospectuses for Ponzi investments will often include critical boilerplate language stating that the securities are not traded on any securities exchange, not approved by the SEC or both.
If the burned investor can establish that the lawyer or accountant has affirmatively made false statements, the investor “must demonstrate that he or she relied on the misrepresentation when entering the transaction that caused him or her economic harm.”
A charge of aiding and abetting liability against a lawyer under Rule 10(b) is especially tough to prove if there was no fiduciary relationship between the lawyer and the investor. In such a situation, the investor has to argue that the lawyer display an “actual intent to aid in [the] primary fraud” instead of mere “recklessness.”
The 1988 federal appeals court decision First Interstate Bank v. Chapman & Cutler dealt with a case in which the defendant—a law firm—had allegedly made misstatements in connection with an initial bond offering to finance a nursing home. In a “classic Ponzi scheme,” the proceeds of subsequent bond offerings were used to repay the initial offering.
First Interstate Bank, representing a group of burned investors, argued that “the subsequent bond issues were the inevitable result of the defendants’ need to acquire funds to avoid defaulting on the [initial] issue.” It also argued that but for the law firm’s misleading statements, it would have avoided the investment. These arguments worked at trial but were eventually reversed.
The appeals court dismissed the bank’s charges and ruled that “something more than but-for causation is required.” It concluded that while the issuance of the bonds might have been foreseeable, the misuse of the bond proceeds “constitute[d] a superseding event” and, therefore, the attorneys were not liable.
The second charge, omission, is more difficult to articulate. To begin, a burned investor has to show that the lawyer or accountant had a specific fiduciary duty or “other relation of trust” to the investors. (This usually isn’t the case, any duty they have usually goes to the company that is paying their bills.)
As the U.S. Supreme Court explicitly stated in its Central Bank decision, “[w]hen an allegation of fraud is based upon nondisclosure,