You Can't Cheat an Honest Man - James Walsh [136]
After greedy lawyers and accountants, the next best place to turn for some recovery is the financial sector. A burned investor will sometimes have success suing the banks, brokerages and institutional financial supporters that help Ponzi schemes flourish. (Often, burned investors will turn to the finance people first. That’s a mistake. Professionals are usually insured against bad advice. And—regardless of what the law says—professionals are usually more culpable.)
A burned Ponzi investor can almost always make a couple of charges against banks and financial institutions. The first is the same charge that works for lawyers and accountants—namely, that these outsiders materially supported the fraud by making mistatements or omissions that led the greedy naifs to invest. The second charge is that banks, by supporting the Ponzi scheme aggressively, became promoters of the fraud. All things being equal, this charge is easier to make against institutions than individuals—though an investor can make it against either group.
Finally, the burned investor can charge that the bank or financial institution actually participated in the scheme. This charge is usually made against brokerages and financial marketing companies...but sometimes it works for banks.
Some angry investors try to implicate a bank simply because it allowed a Ponzi perp to keep a checking account in one of its branches— and cashed the investors’ checks. This argument almost never works. Banks have a long history of court decisions on their side, which says that they’re not responsible when customers use their accounts to perpetrate crimes.
One example of a pro-bank ruling sums up this defense:
Banks handle a high volume of transactions and cannot be required to supervise the checking account activity of their customers, nor should they be potentially liable for the fraudulent activities of their customers.
And another elaborates:
Facts which warrant suspicion would not necessarily cause the bank to know, or have reasonable cause to know, that the Ponzi [perp] was bankrupt, or that he was a swindler. Banks are under no duty at law to warn the investing public as to the financial condition of their depositors. Investors may be assumed to keep themselves reasonably informed as to the financial capacity of persons with whom they are dealing in their investments.”
Key Standards of Bank Culpability
In the 1988 federal appeals court decision Williams v. California 1st Bank, the Ponzi company—a distributor of Mexican seafood—sold investment contracts to individual investors, with a bank serving as the depository.
After the investment program collapsed, the trustee sued the bank on behalf of the estate and the investors, alleging securities law violations arising out of the bank’s involvement in the scheme. Since the trustee and the estate would recoup only administrative costs from a favorable judgment, and the investors would receive the bulk of any recovery, the court noted that the “investors plainly remain the real parties in interest in these actions.”
As a result, the court held that the trustee lacked standing because the money was owed to the investors, not the estate. The appeals court held that the investors, and not the trustee representing the distributorship, had standing to sue for the loss. In reaching this conclusion, the court noted that because the seafood company and the bank were—effectively—partners in committing the fraud, the bankrupt company had no claim against the bank.
Of course, a burned investor could pursue a claim. But even the burned investor will run into some problems. The Supreme Court’s 1994 decision Central Bank of Denver v. First Interstate Bank of Denver restricted the degree to which aiding and abetting liability can be applied to banks and financial institutions that assist Ponzi schemes.
In that case, burned investors sued a trustee on the theory that it aided and abetted Rule 10(b) violations by “recklessly ignoring its oversight duties.” Ruling that the claim could not stand, the Supreme Court found that