The financial crisis brought with it the exposure and collapse of hundreds of Ponzi schemes, 1A Ponzi scheme, also known as a pyramid scheme, occurs when potential investors are promised high rates of return on an investment. The returns are paid out of new investors’ principal, not from actual profit. The scheme can continue as long as it is bringing in sufficient new investors to offset withdrawals by old investors. many of them headline news over the past five years. Scrambling to recover their lost investments, defrauded investors have turned to the courts. And with the shell companies run by the Ponzi scheme perpetrators typically bankrupt, victim-investors have pointed the finger elsewhere: at the banks where the perpetrators held accounts. The logic goes (according to these investors) that whatever tort the Ponzi schemer committed, the bank was liable for aiding and abetting by way of the banking services that it provided. Plaintiffs have also attempted to hold banks liable on other tort-based theories such as negligence, conspiracy, and conversion.
Despite the influx of lawsuits against banks, courts have consistently dismissed the suits for sound legal and policy reasons, and three main themes have emerged. First, banks do not owe a duty to non-customers. Thus, negligence and breach of fiduciary duty claims against banks have failed for want of any duty owed to the investor/non-customer. Second, “red flags”—suspicious, atypical banking activity—do not constitute “actual knowledge,” an element that must be proven for an aiding and abetting claim. Third, providing routine banking services for a client is not enough to constitute “substantial assistance,” another element that must be proven for an aiding and abetting claim.
In short, recognizing the danger of allowing plaintiffs to hold banks liable for the intentional torts of their customers, courts have rightfully imposed a high standard of pleading for allowing these claims to go forward.
I. A Brief Background
In 2009, the recession caused the collapse of nearly four times as many Ponzi schemes as in 2008, beginning with the collapse of Bernie Madoff’s $50 billion dollar enterprise. 2Curt Anderson, Ponzi Scheme Collapses Nearly Quadrupled in ’09, Associated Press, Dec. 29, 2009, available at http://www.boston.com/business/articles/2009/12/29/ponzi_scheme_collapses_nearly_quadrupled_in_09/. With the financial crunch, investors stopped putting in as much money and attempted to withdraw large amounts—two things that a Ponzi scheme, by its very nature, cannot sustain. According to a former Assistant Attorney General for the Department of Justice’s criminal division, “the financial meltdown … resulted in the exposure of numerous fraudulent schemes that otherwise might have gone undetected for a longer period of time.” 3Id. Even today, in 2013, in monitoring new filings across the United States, there is a new case filing every day arising out of a Ponzi scheme.
In the wake of the failure of many of these fraudulent scams, the victims began bringing private actions, attempting to hold related entities such as investment firms, accounting firms, insurers, law firms, and banks liable to recover their lost investments. The most active dockets have been in the Second Circuit (with most cases in New York), the Sixth Circuit (with most cases in Michigan and Ohio), the Ninth Circuit (with most cases in California), and the Eleventh Circuit (with most cases in Florida). Some of the most common causes of action include negligence and aiding and abetting of fraud, breach of fiduciary duty, and conversion.
II. The Tort Law Framework
Aiding and abetting is arguably the theory that plaintiffs have leveraged most often to try to hold banks liable for Ponzi scheme losses. In most jurisdictions, the aiding and abetting standard is the same: The plaintiff must allege (1) an underlying violation on the part of the primary wrongdoer; (2) knowledge of the underlying violation by the alleged aider and abettor; and (3) substantial assistance in committing the wrongdoing by the alleged aider and abettor. 4Lawrence v. Bank of Am., N.A., 455 F. App’x 904, 904 (11th Cir. 2012); see also In re Agape Litig., 773 F. Supp. 2d 298, 307 (E.D.N.Y. 2011) (hereinafter “Agape II”) (In order to successfully establish an aiding and abetting claim, the “plaintiff must show (1) the existence of a fraud; (2) the defendant’s knowledge of the fraud; and (3) that the defendant provided substantial assistance to advance the fraud’s commission.”); Restatement (Second) of Torts § 876(b) (1979). Most courts assessing Ponzi cases have focused on the second and third elements.
Negligence-based claims also are common. Generally, to state a claim for negligence, the plaintiff must establish that (1) the defendant owed the plaintiff a cognizable duty of care; (2) the defendant breached that duty; and (3) the plaintiff suffered resulting damages. 5MLSMK Inv. Co. v. JP Morgan Chase & Co., 737 F. Supp. 2d 137, 145-46 (S.D.N.Y. 2010) (hereinafter “MLSMK I”), aff’d in relevant part, 431 F. App’x 17 (2d Cir. 2011) (hereinafter “MLSMK II”). In the context of Ponzi scheme litigation against banks, the first element of establishing a negligence claim has proven to be the most problematic for plaintiffs.
As another preliminary matter, courts also have been reluctant to expand potential common law liability beyond suits brought by the investors/victims themselves. Indeed, the Court of Appeals for the Second Circuit recently held that such claims—to the extent they have any hope of surviving—cannot be brought against a bank by the bankruptcy trustee for the insolvent Ponzi scheme entity but must be pursued, if at all, directly by aggrieved investors. 6In re Bernard L. Madoff Inv. Secs. LLC, —- F.3d —-, 2013 BL 163325, at *3 (2d Cir. June 20, 2013) (ruling that trustee was barred from asserting claims on behalf of estate by in pari delicto doctrine and lacked standing to bring claims on behalf of investors). Accordingly, any discussion of potential tort-based liability should now be narrowed to direct claims by defrauded investors.
III. Theme I: No Requirement for Banks
To Police Customers
To Protect Non-Customers
As described above, to establish a negligence claim, the plaintiff must demonstrate, inter alia, that the defendant owed a duty as a matter of law. 7In re Agape Litig., 681 F. Supp. 2d 352, 359 (E.D.N.Y. 2010) (hereinafter “Agape I”). To demonstrate that threshold element, however, “the injured party must show that a defendant owed not merely a general duty to society, but a specific duty to him or her, for without a duty running directly to the injured person there can be no liability in damages, however careless the conduct or foreseeable the harm.” 8Id. at 359-60.
The general rule in New York (the birthplace of many decisions considering the liability of banks in Ponzi cases) is that “banks do not owe non-customers a duty to protect them from the intentional torts of their customers.” 9Id. at 360; see also MLSMK I, 737 F. Supp. 2d at 146 (“[I]t is evident that banks do not owe non-customers a duty to protect them from the intentional torts of their customers.”) (internal citations omitted); MLSMK II, 431 F. App’x at 20 (“Banks generally do not owe non-customers a duty to protect them from fraud perpetrated by customers.”); Musalli Factory For Gold & Jewellry v. JP Morgan Chase Bank, 261 F.R.D. 13, 27 (S.D.N.Y. 2009) (“Banks do not owe non-customers a duty to protect them from the intentional torts of their customers.”), aff’d, 382 F. App’x 107 (2d Cir. 2010). Similarly, in the Eleventh Circuit, Florida courts have held that a bank owes no duty to a non-customer. “Florida law does not require banking institutions to investigate transactions.” 10In re Palm Beach Fin. Partners, L.P., 488 B.R. 758, 774 (Bankr. S.D. Fla. 2013) (citing Lawrence, 455 F.App’x at 907). Indeed, “a bank has the right to assume that individuals who have the legal authority to handle the entity’s accounts do not misuse the entity’s funds.” 11Id. at 774 (citing O’Halloran v. First Union Nat’l Bank, 350 F.3d 1197, 1205 (11th Cir. 2003)); see also Perlman v. Wells Fargo Bank, No. 10-cv-81612, 2012 BL 203950, at *2 (S.D. Fla. Aug. 10, 2012) (same); Wiand v. Wells Fargo Bank, No. 8:12-cv-00557, 2013 BL 93572, at *3 (M.D. Fla. Apr. 5, 2013) (noting that even for seemingly atypical transactions, banks are not required to investigate the holder’s transactions).
In a case in the Eastern District of New York, Agape I, the plaintiffs attempted to use an exception to the general rule, applicable to trust accounts, to impose a duty upon the defendant bank. 12Agape I, 681 F. Supp. 2d at 360. The exception provides that where a bank “has knowledge that funds it holds are being improperly misappropriated by a fiduciary,” the bank must “make reasonable inquiry and endeavor to prevent a diversion” of funds. 13Id. The court rejected the use of this exception, as the accounts at issue were “merely conventional depository accounts” and not trust accounts. 14Id. Because the plaintiffs could not provide any authority “even suggest[ing] that New York law imposes upon banks a duty to protect non-customers from a fraud involving depository accounts,” the court had no basis “to depart from the general rule that banks do not owe non-customers a duty to shield them against intentional torts committed by bank customers.” 15Id. (emphasis in original). Indeed, the District Court of Arizona has observed that without a fiduciary duty, banks have no duty to disclose to a customer the potential fraud of another customer, and in fact, banks have a duty not to disclose their customers’ financial conditions to anyone else. Stern v. Charles Schwab & Co., No. 09-cv-1229, 2009 BL 224036, at *5 (D. Ariz. Oct. 16, 2009).
In Lawrence v. Bank of America, one of the leading Ponzi scheme cases out of the Eleventh Circuit, victims of a Ponzi scheme alleged that the bank authorized “numerous deposits, withdrawals, and wire transfers involving large amounts of money,” and that the “transactions were atypical and therefore Bank of America should have known of the Ponzi scheme.” 16Lawrence, 455 F. App’x at 907. The court rejected these arguments, finding that liability was not triggered because “Florida law does not require banking institutions to investigate transactions” and the bank, “in providing only routine banking services[,] was not required to investigate.” 17Id. Likewise, the Southern District of Florida, using Lawrence as guidance, has reiterated that “banks have no duty to investigate even suspicious transactions.” 18Perlman, 2012 BL 203950, at *1-2 (emphasis added).
Courts thus have been reluctant to stray from the basic rule that banks do not owe a duty to non-customers and are not responsible for the intentional torts of their customers. To be sure, to find otherwise would be to “unreasonably expand a bank’s orbit of duty.” 19Musalli, 261 F.R.D at 27 (internal citations omitted) (finding that because there was no cognizable duty of care of the bank to the non-customer plaintiff, negligence count had to be dismissed). The case law that has emerged since 2008 has demonstrated the courts’ unwillingness to expand that duty.
IV. Theme II: Banks Should Not Be Held
Responsible on Basis of `Red Flags’
In addition to consistently finding that banks owe no duty to non-customers, courts have repeatedly held that “red flags” are not sufficient to establish actual knowledge for purposes of an aiding and abetting claim. Rather, the plaintiff must allege “that the defendant had actual knowledge of the wrongful conduct committed, not simply that the defendant should have known of the conduct.” 20Agape II, 773 F. Supp. 2d at 308 (emphasis added); see also Groom v. Bank of America, No. 8:08-cv-2567, 2012 BL 6305, at *3 (M.D. Fla. Jan. 9, 2012) (A person “knows or has knowledge of a fact when the person has actual knowledge.”). Therefore, “statements alleging that a defendant should have known that something was amiss with transactions … are insufficient to support an aiding-and-abetting claim.” 21Agape II, 773 F. Supp. 2d at 308 (internal citations omitted); see also Platinum Estates, Inc. v. TD Bank, No. 11-cv-60670, 2012 BL 54249, at *3 (S.D. Fla. Mar. 8, 2012) (“Conclusory statements that a defendant actually knew [are] insufficient to support an aiding and abetting claim where the facts in the complaint only suggest that the defendant should have known that something was amiss.”); Wiand, 2013 BL 93572, at *3 (noting that evidence that a bank “should have known” does not suffice); Palm Beach, 488 B.R. at 773 (finding that allegations that a bank should have known that something was wrong are not actual knowledge).
Nor will allegations that a bank ignored “red flags” or other signs supposedly indicative of fraud establish the requisite actual knowledge. 22Rosner v. Bank of China, No. 06-cv-13562, 2008 BL 289522, at *11 (S.D.N.Y. Dec. 18, 2008) (“[A] bank’s ignorance of ‘red flags’ or obvious warning signs of fraudulent activity cannot establish a bank’s actual knowledge sufficient to support a claim of aiding and abetting….”), aff’d, 349 F. App’x 637 (2d Cir. 2009). Thus, in considering whether the defendant had actual knowledge for purposes of aiding and abetting, a bank’s “lapse of wary vigilance, disregard of suspicious circumstances which might have well induced a prudent banker to investigate and other permutations of negligence are not relevant considerations.” 23MLSMK II, 431 F. App’x at 19 (internal citations omitted). As such, in many jurisdictions, “courts have routinely held that when a defendant is under no independent duty, even alleged ignorance of obvious warning signs of fraud will not suffice to adequately allege ‘actual knowledge.’” 24de Abreu v. Bank of Am. Corp., 812 F. Supp. 2d 316, 323 (S.D.N.Y. 2011). A review of cases from several jurisdictions is instructive.
New York
In Agape I, the plaintiffs attempted to allege the knowledge element of aiding and abetting by claiming that Bank of America established an unofficial branch within Agape headquarters and an employee staffed there had access to Agape’s business records and contact with the Ponzi scheme perpetrator. 25Agape I, 681 F. Supp. 2d at 362. Plaintiffs also asserted that knowledge could be inferred from the fact that Agape and Bank of America shared proprietary information, including that of customer accounts. 26Id. The court rejected this logic, stating that it did not give rise to the inference that the bank’s employee was complicit in the Ponzi scheme. 27Id. The court also noted that while allegations that the bank overlooked red flags did not reflect well on the bank’s monitoring system, it did not create an inference of actual knowledge. 28Id. at 363-64.
Florida
In Groom v. Bank of America, a case arising out of Lou Pearlman’s Ponzi scheme, the court found that the plaintiffs could not show that the bank was aware of Pearlman’s breach of duty simply because he “deposited vast sums of money” or engaged in other unusual transactions. 29Groom, 2012 BL 6305, at *3. Rather, the court held,“[s]uch red flags do not constitute the conscious awareness of wrongdoing necessary to maintain an aiding and abetting cause of action.” 30Id.
Michigan
Likewise, in El Camino Resources, Ltd. v. Huntington National Bank, the court found that the bank, at most, had a strong suspicion of wrongdoing because of atypical account behavior and because the bank knew that one of the Ponzi scheme perpetrators had been sanctioned by the SEC for a securities violation. However, the bank did not know the nature of the shell company’s transactions, how it operated, or with whom it did business. 31See El Camino Res. Ltd. v. Huntington Nat’l Bank, 712 F.3d 917 (6th Cir. 2013) (hereinafter “El Camino II”).
California
By the same token, in Fowler v. La Salle Bank, the California Court of Appeal noted that although plaintiff detailed the bank’s “knowledge of facts that caused it to suspect ‘something fishy’ was going on,” plaintiff did not allege facts showing that the bank actually knew the Ponzi schemer was defrauding plaintiff by selling her unregistered securities. 32No. D051864, 2009 BL 309187, at *7 (Cal. Ct. App. Feb. 4, 2009). As the court succinctly held, “suspicion and surmise do not constitute actual knowledge.” 33Id.
Arizona
Finally, the plaintiffs in Stern attempted to allege scienter by claiming that the bank knew of the Ponzi schemers’ financial history, including lack of income and debt, and that millions of dollars in deposits and withdrawals were made into and out of their account over five months. 34Stern, 2009 BL 224036, at *7. The court noted that while the plaintiffs’ arguments may have suggested that the bank engaged in poor business practices, they did not show that the bank knew that the Ponzi schemers were perpetrating a fraud. In the court’s words, “[k]nowledge of suspicious activity is not enough.” 35Id. at *8.
*****
Despite the trend away from “red flags,” some courts have found that a plaintiff may meet the actual knowledge requirement through allegations of conscious avoidance. 36See, e.g., Agape I, 681 F. Supp. 2d at 352; Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 2d 372 (S.D.N.Y. 2010). As to evidentiary requirements, one court in the Sixth Circuit has held that actual knowledge for an aiding and abetting claim may be demonstrated circumstantially. Metz v. Unizan Bank, No. 5:05-cv-1510, 2008 BL 343810, at *13 (N.D. Ohio Feb. 8, 2008), aff’d, 649 F.3d 492 (6th Cir. 2011). Accordingly, “the details of a particular transaction may be sufficient to allow an inference of knowledge on the part of a bank.” Id. Conscious avoidance “‘occurs when it can almost be said that a defendant actually knew because he or she suspected a fact and realized its probability, but refrained from confirming it in order later to be able to deny knowledge.’” 37Agape II, 773 F. Supp. 2d at 308 (quoting Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt., LLC, 479 F. Supp. 349, 368 (S.D.N.Y. 2007)). Demonstrating actual knowledge based on conscious avoidance “is a very high bar” and “requires facts supporting an inference that the defendant acted with a culpable state of mind.” 38Id. at 308-09, 319. The court in Agape II noted that “there is no reason to spare a putative aider and abettor who consciously avoids confirming facts that, if known, would demonstrate the fraudulent nature of the endeavor he or she substantially furthers.” 39Id. at 309 (internal citations omitted). However, the court cautioned that “this standard does not impose a duty on a bank to take actions they otherwise would not have taken based on a suspicion of fraud.” 40Id. Instead, conscious avoidance would be found where the defendant avoided taking actions it otherwise would have, “specifically to avoid attributable knowledge of the underlying fraudulent scheme.” 41Id. For that reason, the Agape II court held that where “it was bank policy not to investigate” and the bank did not decline to investigate “specifically to avoid learning of the Agape fraud,” the bank’s “decisions not to voluntarily investigate the fraud at any other point, even when faced with ‘red flags’ in the account activity, [did] not constitute conscious avoidance.” 42Id. at 320-21.
The high degree of scienter required for aiding and abetting liability is well supported by sound policy arguments in many courts’ decisions. 43See, e.g., El Camino Res. Ltd. v. Huntington Nat’l Bank, 722 F. Supp. 2d 875, 905 (W.D. Mich. 2010) (hereinafter “El Camino I”) (“To prevent banks, attorneys and others from incurring near strict liability for the torts of their clients, a high degree of scienter is necessary to extend fraud liability on an aiding-and-abetting theory.”), aff’d, 712 F.3d 917 (6th Cir. 2013). For example, the Western District of Michigan in El Camino observed that:
[I]nsistence on actual knowledge of specific wrongdoing … [stems] from a desire to avoid unjust results. In the commercial context, the close relationship between banks … and their clients makes these entities inviting targets for lawsuits stemming from client wrongdoing. These institutions will always have more information about the client’s conduct than the general public, making them vulnerable to the hindsight accusation that they knew of the client’s wrongdoing or were wilfully blind. Courts are unwilling to make such institutions the guarantors of their customers’ conduct…. The Sixth Circuit in Aetna Casualty recognized that a bank’s actual knowledge of a fraudulent scheme is the crucial element that prevents it from suffering automatic liability for the conduct of its customers. Any contrary rule would have a devastating impact on commercial relationships. 44Id. at 908 (internal citations omitted).
With these policy principles in mind, courts continue to require that a plaintiff show the bank’s actual knowledge to sustain an aiding and abetting claim. This high standard rightly aims to prevent banks from becoming their customers’ keepers.
V. Theme III: Routine Banking Services
Do Not Constitute Substantial Assistance
The final element of an aiding and abetting claim is substantial assistance. Through Ponzi scheme litigation, the principle has emerged that providing routine banking services to a Ponzi scheme perpetrator does not rise to the level of assistance necessary to establish aiding and abetting liability.
Substantial assistance means “something more than merely providing routine professional services that aid the tortfeasor in remaining in business, but do not proximately cause the plaintiffs’ harm.” 45Id. at 911. Therefore, substantial assistance is generally found where “(1) a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed; and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated.” 46Musalli, 261 F.R.D. at 25 (internal citations omitted). As a practical matter, “courts generally hold that a bank does not aid and abet its customer’s wrongdoing merely by providing routine banking services to its customer.” 47El Camino I, 722 F. Supp. 2d at 911 (citing Rosner v. Bank of China, 528 F. Supp. 2d 419, 427 (S.D.N.Y. 2007)); see also Musalli, 261 F.R.D. at 25 (“The mere fact that the participants in a fraudulent scheme use accounts at a bank to perpetrate it, without more, does not in and of itself rise to the level of substantial assistance.”).
Providing ordinary banking services may satisfy the substantial assistance element of an aiding and abetting claim “only if the bank actually knew those transactions were assisting the customer in committing a specific tort.” 48El Camino I, 722 F. Supp. 2d at 913 (emphasis added). Consequently, “the mere maintenance of a bank account and the receipt or transfer of funds,” without more, do not equate to substantial assistance. 49Id. at 927-28; see also Metz, 2008 BL 343810, at *14 (“[T]he claim that a principal tortfeasor uses bank accounts to perpetuate a fraud is insufficient to support an allegation of substantial assistance required for aiding and abetting liability.”).
Similarly, a failure to act “constitutes substantial assistance only when the defendant had an independent duty directly to the plaintiff. A failure to investigate, i.e., constructive knowledge, is not enough to support a claim for aiding and abetting a fiduciary absent the existence of a fiduciary duty running from defendant to plaintiff.” 50El Camino I, 722 F. Supp. 2d at 911-12. In Groom, the plaintiffs contended that the defendant banks “failed to adhere to the customary and accepted standard of care and failed to monitor incoming deposits and wires and other monies entrusted to them.” 51Groom, 2012 BL 6305, at *3. However, the court reiterated that the allegation of a failure to act, absent a duty, is not substantial assistance. 52Id. at *4.
Likewise in Agape II, the court noted that “the caselaw is clear that opening accounts and approving transfers, even where there is a suspicion of fraudulent activity, does not amount to substantial assistance.” 53Agape II, 681 F. Supp. 2d at 365 (internal citations omitted). Additionally, the bank had no affirmative duty to discover the perpetrator’s fraud. 54Id. Therefore, the court dismissed claims of aiding and abetting fraud and breach of fiduciary duty.
Furthermore, “but-for causation” has been “universally rejected” by courts, as they have required the defendant’s acts of substantial assistance to be the proximate cause of the plaintiff’s harm. 55El Camino I, 722 F. Supp. 2d at 929; see also In re Consol. Meridian Funds, 485 B.R. 604, 617 (Bankr. W.D. Wash. 2013) (finding that for substantial assistance prong of aiding and abetting breach of fiduciary duty, the plaintiff must show that the defendant enabled the fraud to proceed and proximately caused the harm on which primary liability is predicated); Morof v. United Mo. Bank, No. 08-10526, 2009 BL 93656, at *9 (E.D. Mich. Apr. 30, 2009) (“Plaintiffs have not and cannot establish that Defendant Bank’s conduct was the proximate cause of the monetary losses they suffered as a result of their decision to invest in what turned out to be a Ponzi scheme.”), aff’d, 391 F. App’x 534 (6th Cir. 2010). In El Camino, the plaintiffs posited that the bank was liable if it helped to “perpetuate the enterprise.” 56El Camino I, 722 F. Supp. 2d at 914. The court rejected this theory, aptly noting that:
One might as easily hold the grocer liable for aiding and abetting Al Capone, on a showing that the grocer suspected Capone was a hoodlum but sold him food anyway, allowing him to live another day to commit his crimes. 57Id.
Therefore, the plaintiffs’ allegations that the bank kept the sham company alive during the time of its fraudulent activity were not enough. 58Id. at 929.
Finally, in Stern, with regard to substantial assistance, the court stated that processing day-to-day banking transactions does not constitute substantial assistance unless the bank has an “extraordinary economic motivation to aid in the fraud.” 59Stern, 2009 BL 224036, at *8. The plaintiffs alleged no such motivation, and therefore, the bank’s motion to dismiss was granted.
The reasoning borne from this line of case law shows the courts’ recognition of the potentially untethered liability that could result if “but for” causation were an appropriate method of showing substantial assistance. Further, time and again, courts have demonstrated their reluctance to hold banks liable for their customers’ conduct when the bank merely provided routine banking services, without some extra “plus” factor.
VI. Conclusion
As the case law that has developed since 2008 shows, courts have been unwilling to hold banks liable for the intentional torts of their customers unless plaintiffs meet a high pleading standard. Based on previously established common law legal principles and sound policy rationales, courts have reiterated that banks owe no duty to non-customers and have required plaintiffs to adequately allege actual knowledge and substantial assistance for aiding and abetting claims. And as the Second Circuit Court of Appeals’ recent decision in the Madoff bankruptcy indicates, courts are increasingly narrowing the avenues to bank-borne liability. With each decision, and particularly those in the Second, Sixth, Ninth, and Eleventh Circuits, courts consistently impose strict requirements for allowing Ponzi scheme liability cases to go forward, and it appears that this trend will continue.
