Ponzi schemes involving investor funds are, unfortunately, all too common. The underlying fraud of those who orchestrate the Ponzi scheme fits squarely within the elements of a fraud cause of action. Often, however, the fraudsters have squandered the investor funds and are unable to pay the resulting damages. In such circumstances, victims of the fraud seek to recover from others who may be “deep pockets” and who may have participated in the fraud or “aided and abetted” the fraud.
One common scenario is where the fraudsters use bank accounts to funnel and divert the investor funds. In such circumstances, investors seek to assert claims of aiding and abetting fraud against the involved banks. These claims are analyzed under the traditional framework of the cause of action of aiding and abetting fraud.
A recent decision of the United States District Court for the Western District of New York took a dim view of such claims and dismissed them pursuant to FRCP 12(b)(6) – Heinert v. Bank of America, 19-CV-6081L, (USDC WDNY Oct. 18, 2019).
Heinert Facts
Plaintiffs sued on behalf of themselves and over 600 other investors alleging that several individuals, assisted by employees of defendants Bank of America, N.A. and its successor, Citizens Bank, N.A., perpetrated a nearly decade-long Ponzi scheme by which the plaintiffs and other putative class members were defrauded of approximately $102 million.
Plaintiffs alleged that due to the personal and business banking relationships between the individual defendants and the defendant banks, the defendant banks were liable for the fraudulent scheme as well. Specifically, plaintiffs alleged that several of the individual defendants converted a previously legitimate investment brokerage enterprise into a fraudulent scheme, by which they misused and misappropriated investor funds to pay off previous investors and to fund their own “jet-setting lifestyle.” Plaintiffs contended that defendants, in facilitating the scheme, opened and transferred funds in and out of more than one hundred accounts at Bank of America, and twenty accounts at Citizens.
Plaintiffs also alleged that a bank employee who first worked at Bank of America and then at Citizens, was instrumental in facilitating the scheme perpetrated by the fraudsters. In particular, plaintiffs alleged this employee coordinated the opening of new accounts, expedited the availability of funds, lied to creditors, falsely confirmed that accounts held sufficient funds to cover debts, and engaged in “atypical” transactions and transfers on the individual defendants’ behalf. This employee also received a “loan” of $40,000 from the fraudsters, which she never repaid.
Plaintiffs named the banks as defendants, alleging claims of aiding and abetting fraud and breach of fiduciary duty. The banks moved to dismiss the complaint under FRCP 12(b)(6).
Court Dismisses Aiding and Abetting Fraud Claims
Like CPLR 3016(b), FRCP 9(b) requires that claims of fraud and aiding and abetting fraud be pled with specificity. The Court in Heinert thus first observed:
With respect to claims of aiding and abetting fraud and/or aiding and abetting a breach offiduciary duty sounding in fraud, the Second Circuit also applies the heightened pleading standard of Fed. R. Cir. Proc. 9(b), which requires that “the circumstances constituting fraud or mistake shall be stated with particularity.” See Lerner v. Fleet Bank, N.A., 459 F.3d 273 at 290 (2d Cir. 2006); …
The Court went on to rule that plaintiffs had not stated plausible claims against the banks. I have observed state court decisions that were not as exacting in evaluating claims of aiding and abetting fraud against banks. See, for example, my prior post. Here, the federal court gave no leeway in rejecting the claims. The decision in Heinert is a good roadmap for banks seeking to challenge such claims in federal court.
The Court cited the elements of the claim, relying on a Second Circuit decision applying New York substantive law:
In order to plead a cause of action against a bank for aiding and abetting fraud committed by account-holders, a complainant must plausibly allege: (1) the existence of a fraud; (2) the defendant bank’s knowledge of the fraud; and (3) that the defendant bank provided substantial assistance to advance the fraud’s commission. Lerner v. Fleet Bank. N.A., 459 F.3d 273, 292 (2d Cir. 2006).
The Court then analyzed the element of knowledge of the fraud:
With respect to the element of knowledge, plaintiffs must plausibly allege actual knowledge of the underlying fraud on the part of the defendant banks: constructive knowledge is not sufficient, nor is “a lower standard such as recklessness or willful blindness.” Rosner, 2008 U.S. Dist. LEXIS 105984 at *22 (quoting Pension Comm. Of Univ. of Montreal Pension Plan v. Banc of Am. Sec., LLC, 446 F. Supp. 2d 163, 202 n.279 (S.D.N.Y. 2006)). See also In re Agape Litig. v. Cosmo, 773 F. Supp. 2d 298, 308 (E.D.N.Y. 2011).
Although the key employee of the banks was certainly deep into the fraudulent conduct of their customers, the Court gave plaintiffs no slack in rejecting these allegations, citing a number of federal decisions in favor of banks:
See generally In re Agape Litig., 773 F. Supp. 2d 298, 315 (close relationship between a bank employee and perpetrators of a Ponzi scheme is insufficient to give rise to an inference that the bank had actual knowledge of the scheme); Renner v. Chase Manhattan Bank, 2000 U.S. Dist. LEXIS 8552 at *34-*37 (S.D.N.Y. 2000) (fact that bank’s branch manager had an ongoing relationship with fraudsters is insufficient to impute actual knowledge of the fraud to the bank, without allegations that the bank defendant had reason to believe that the bank manager was engaged in, or assisting, fraudulent conduct). Plaintiffs also do not specifically allege that Bank of America’s internal investigation revealed, or otherwise placed Bank of America on notice, of the alleged fraudulent scheme.
It is well settled in the Second Circuit that a bank’s negligent failure to identify warning signs of fraudulent activity, such as atypical transactions – even where such signs converge to form Case 6:19-cv-06081-DGL Document 46 Filed 10/18/19 Page 5 of 12 a veritable “forest of red flags’” – is insufficient to impute actual knowledge of ongoing fraud. See e.g., Lerner, 459 F.3d 273 at 292-94 (bank’s knowledge of “red flags”, i.e., that attorney’s fiduciary accounts were frequently overdrawn and contained insufficient funds, and that attorney repeatedly transferred funds from fiduciary accounts to his own personal accounts, did not give the bank actual knowledge that the attorney was engaged in fraud); Rosner (collecting cases, and finding that allegations that a bank processed frequent atypical, non-routine transactions, and/or that it was aware of other fraudulent schemes similar to the one alleged, are insufficient to give rise to a “strong inference” of actual knowledge); Yao-Yi, 301 F. Supp. 3d 403 at 420 (allegations that a bank’s managers had a close professional relationship with fraudsters, and that the bank was aware that a high volume of “atypical money transfers” were occurring between investor accounts, are insufficient to establish actual knowledge). See also In re Agape Litig., 773 F. Supp. 2d 298 at 310 (“[w]here, as here, the defendant owes no independent duty to the Plaintiffs, even alleged ignorance of obvious warning signs of fraud will not suffice to adequately allege actual knowledge”) (internal quotation marks omitted); Chemtex, LLC v. St. Anthony Enters., 490 F. Supp. 2d 536, 546 (S.D.N.Y. 2007) (“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’”). Similarly, allegations concerning a bank’s willingness to “bend its rules” to accommodate influential customers by processing irregular transactions does not give rise to a “strong inference” of actual knowledge that those customers are engaged in fraud. Rosner, 2008 U.S. Dist. LEXIS 105984 at *37.
…
In short, while plaintiffs’ allegations clearly establish that Cunningham performed a series of atypical activities, willfully misrepresented the individual defendants’ account balances to American Express, and demanded a loan from the individual defendants, plaintiffs’ allegations provide no factual basis to establish that Cunningham had actual knowledge that she was assisting the individual defendants to perpetrate a fraudulent scheme. (Dkt. #1 at ¶92). See generally Musalli Factory for Gold & Jewellry v. JP Morgan Chase Bank, N.A., 261 F.R.D. 13, 25 (S.D.N.Y. 2009) (allegations that bank employee acted suspiciously after a fraud was committed do not establish actual knowledge of the fraud at the time it took place).
Commentary
As with many fraud cases, the same general principles of law can be applied to different facts, leading to starkly different results. In Heinert, the federal court strictly reviewed the allegations and refused to expand liability for the fraudulent Ponzi scheme perpetrated by the individual defendants to the banks, notwithstanding the intimate connection between the fraud and the banks’ employee’s involvement. Heinert is a good source and precedent for those seeking to defeat claims of aiding and abetting fraud.