You Can't Cheat an Honest Man - James Walsh [137]
While the Central Bank decision severely curbed actions against secondary actors, the court admitted that such actors are not “always free from liability under the securities acts.” Specifically, it wrote:
Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator....
So, a burned investor has to prove that the bank—or its personnel— were actively involved in promoting the scheme. Of course, the relationship between a Ponzi perp and his bank isn’t always clear. Many perps use unwitting banks—or groups of banks—to create whole systems of bogus transactions intended to hide their tracks. The bank’s liability may seem larger here; but it can be even harder to prove.
When Banks Become Promoters
In his 1914 book Other People’s Money, which studied the concentration of power among New York investment bankers, future Supreme Court Justice Louis Brandeis wrote:
[T]his enlargement of their legitimate field of operations did not satisfy investment bankers.... They became promoters, or allied themselves with promoters.
The Securities Act of 1933 was influenced by Brandeis’ book. As one congressman put it, “The American investor was relying upon the bankers, since faith in the bankers was virtually the only measuring rod for the investor. How certain bankers and brokers have breached that faith is part of this whole sordid story.”
When this line is crossed—which it still sometimes is—banks can be held liable for Ponzi scheme damages. That’s exactly what happened in the Great Rings Estate Limited Partnership scheme.
Great Rings was a distant relative of the infamous—and much larger— Colonial Realty pyramid scheme that shook Connecticut money circles in the late 1980s. One of Colonial’s most successful salesmen was Kenneth Zak. In early 1988, after studying with master Ponzi perps at Colonial, Zak left to strike out on his own.
What he found was Great Rings, which had been started as a limited partnership among several experienced real estate developers. The stated purpose of Great Rings was to purchase four parcels of unimproved land on Great Rings Road in Newtown, Connecticut, upgrade their zoning, and prepare single-family home sites which would then be resold at a profit.
Zak—who had no experience in developing raw acreage—didn’t care what the stated purpose of the vehicle was. To him, it was a method of raising money. He and the founding general partners agreed on an unusual method of financing. Great Rings would solicit investments in the form of limited partnerships. Investors would borrow the entire purchase price of their shares ($50,000 each) from a bank. Their notes would be directly payable to the bank. The partnership would guarantee a return at 8 percent per annum to the investors, to offset the interest on the notes to the bank.
Zak claimed that, in two years, Great Rings would have sufficient funds to pay off the principal—and still have many of the parcels left to sell. So, the general partners would raise millions and the investors would never pay a dime out of their own pockets.
The scheme, while not inherently unlawful, contained a substantial Ponzi element from the very beginning. The raw acreage could not produce income until it was developed and resold, so the only conceivable source of the 8 percent annual return was money from new investors. This aspect of the enterprise was not mentioned in any of the promotional literature or legal filings produced by Great Rings.
The success of the scheme rested on persuading a bank to go along. Zak approached Connecticut National Bank (CNB). In January 1989, he met twice with Neal Fitzpatrick, then a senior vice-president and regional manager of CNB. The first meeting