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Alleged BSA Violations Do Not Support Civil Negligence/Fraud Claims – Again

As we have blogged, courts have held that financial institutions generally do not owe a duty of care to a noncustomer and that no special duty of care arises from the duties and obligations set forth in the Bank Secrecy Act (“BSA”), absent a special relationship or contractual relationship. Moreover, there is no private right of action stemming from the BSA. Nor does the BSA define a financial institution’s standard of care for the purposes of a negligence claim.  A majority panel of the Eighth Circuit (“the Court”) very recently confirmed these principles in a detailed opinion which affirmed summary judgment in favor of a bank which had provided services to the alleged perpetrators of a $193 million Ponzi scheme, thereby rejecting claims brought by a Receiver on behalf of defrauded investors that the bank had aided and abetted fraud, breach of fiduciary duty, and other claims.

After dissecting the record in detail, the Court determined in Zayed v. Associated Bank, N.A. — over a vigorous dissent — that the Receiver failed to present direct or circumstantial evidence that the bank actually knew about the Ponzi scheme being perpetrated by its former customers, much less that it substantially assisted the scheme. The Court emphasized the fact that evidence of possible “sloppy banking” and the existence of potential red flags fell short of the high bar required to sustain a claim for aiding and abetting a fraud against the third party non-customers.

Although the Zayed opinion is one of many cases rejecting AML-inspired tort claims by defrauded investors against a financial institution which had done business with a fraudster, it is notable for its methodical treatment of the facts — many of which appear in one form or another in other cases — regarding the various red flags which the Receiver claimed that the bank had missed, or the alleged misconduct which the Receiver claimed that bank personnel had perpetrated.  The list of alleged compliance failures discussed and found insufficient to establish potential liability in Zayed demonstrates that however rigorous AML/BSA obligations and programs may be for financial institutions, their alleged violations often fail to pave a path to recovery for civil plaintiffs.

In the underlying Ponzi scheme at issue in Zayed, the fraudsters told potential investors that their investments would be held in segregated accounts, completely liquid, and invested in a currency exchange program through a Swiss company (“Swiss Crown Forex”). The fraudsters ultimately were convicted and sentenced to prison for a variety of crimes, including money laundering, mail fraud, and wire fraud.  The bank, therefore, did not dispute that the fraudsters engaged in a Ponzi scheme. Instead, the parties’ dispute hinged on the actual knowledge and substantial assistance of one former bank employee, Sarles, who allegedly opened and serviced eight fraudulent accounts from January 2008 through June 2009.

Applying Minnesota law, which generally tracks the law of other States in this area, the Court noted that plaintiffs must establish the following in an aiding and abetting claim: (1) the primary tortfeasor commits a tort that injures the plaintiff; (2) the defendant knows that the primary tortfeasor’s conduct is a breach of duty; and (3) the defendant substantially assists the primary tortfeasor in committing the tort.

In analyzing the key element of actual knowledge, Minnesota courts consider factors “such as the relationship between the defendant and the primary tortfeasor, the nature of the primary tortfeasor’s activity, the nature of the assistance provided by the defendant, and the defendant’s state of mind.” This requires a showing of more than “awareness of the conduct in question . . . , that it raised red flags, . . . or even that it amounted to gross negligence.” Instead, a plaintiff must show that the defendant “was aware of the wrongfulness of the challenged conduct.” (emphasis in original). This can be a difficult standard for plaintiffs to meet.

Insufficient Evidence of Knowledge

The Eighth Circuit first determined that the record contained no direct evidence that Sarles or anyone else at the bank knew of the Ponzi scheme. It pointed to the testimony of both parties’ experts, Sarles’ coworkers, the bank’s regional officer, and one of the fraudsters that the record was devoid of evidence that Sarles or anyone else “put this information together and determined that there was a Ponzi scheme.” The bank’s regional security officer instead attributed Sarles’ actions, discussed below, to “sloppy banking.”

The Court next considered whether any circumstantial evidence showed that Sarles had actual knowledge of the Ponzi scheme. It determined that – even looking at all of the circumstantial evidence collectively – the Receiver’s claims amounted only to “speculation and conjuncture” because it showed nothing more than “‘sloppy banking’ or ‘red flags’ that, with the benefit of hindsight, should have prompted further investigation or inquiry.” Specifically, the Court considered and rejected the following arguments, among others, cited by the Receiver in an attempt to establish actual knowledge:

  • The Receiver alleged that the fact that Sarles advised Cook, one of the fraudsters, to open one of the accounts under the name of a domestic limited liability company (“U.S. Crown Forex”) rather than under the name of Swiss Crown Forex showed that Sarles knew about the Ponzi scheme and helped prevent its detection. In rejecting this argument, the Court emphasized (1) Cook’s testimony that he did not think Sarles understood this strategy to be improper or fraudulent; and (2) Sarles’ own testimony that he believed the domestic LLC was required.

  • The Receiver argued that the U.S. Crown Forex account was opened as a checking/money market account to help the fraudsters avoid detection and that the bank – which knew the account was intended to hold investor funds – should have selected an account type that indicated fiduciary status or that it held investor funds. Disagreeing, the Court pointed to the fact that (1) the record lacked evidence that the bank had such specific types of accounts or policies requiring their use; and (2) the record did not indicate that the account was intentionally opened as a checking account to avoid detection.

  • The Receiver emphasized the fact that Sarles opened the U.S. Crown Forex account without receiving proof that the company was registered with the Secretary of State. In fact, Sarles never followed up on the paperwork and later learned that the company never registered with the state. The Court likewise rejected this argument, pointing to the fact that Sarles received all other necessary documentation, as well as an application for articles of incorporation that he believed was being submitted to the state.

  • Pointing to one of the fraudster’s (Pettengill’s) claims that Sarles was present at the fraudsters’ investment pitch, the Receiver argued that as a sophisticated banker who received bank secrecy and AML training, Sarles “must have known that the investment pitch was a scam.” At this pitch, the fraudsters promised investors a “risk-free” and “completely safe” investment. However, the Court emphasized Pettengill’s testimony that “Sarles did not say or do anything that would lead [Pettengill] to believe that Sarles did not believe the investment pitch or knew it was fraudulent.”

  • Pettengill also alleged that Sarles attended a meeting at which the fraudsters discussed initiating wire transfers from the Swiss Crown Forex account to the U.S. Crown Forex account, and then back into segregated client accounts in Switzerland. Pettengill claimed that the fraudsters discussed the fact that (1) the Swiss Crown Forex account had a $13 million account shortfall (reflecting a $2 million balance rather than the desired $15 million balance); and (2) the fraudsters needed a “friendly banker” to “make it look clean” and “get around [another bank’s] questioning all the wiring transfers and that bank’s growing suspicions.” According to Pettengill, it was “implied” that the fraudsters were taking these actions to cover up a shortfall of money in the Swiss account, but he also acknowledged that the fraudsters never disclosed to Sarles the manner in which the transfers were to be done. Notably, the Court concluded: “[e]ven assuming Sarles knew there was a shortfall in the Swiss Crown Forex entity, and that the scammers wanted to avoid disclosing that, it does not follow that Sarles knew their enterprise was a Ponzi scheme or that they were engaged in tortious conduct. If true, this should have been a red flag, but it does not show actual knowledge.”

  • The Receiver asserted that Sarles improperly approved transfers of money – at Cook’s behest – from specific accounts in which two separate fraudsters, Kiley and Smith, were signatories, into accounts on which Cook was the signatory. The Court concluded that this “only show[ed] that [Sarles] was being sloppy with formalities when he knew that Cook and Smith (and the other scammers) were working together – it would not show that Sarles knew there was a Ponzi scheme afoot.”

  • The Receiver argued that money continued to flow in and out of the U.S. Crown Forex account after Sarles learned that Swiss authorities had closed the Swiss Crown Forex account. But the Court determined that the Receiver failed to point to any evidence proving that Sarles actually knew about the closure. Importantly, although the Receiver’s own expert report concluded that the bank would have learned of this information if it had performed the proper due diligence, even the Receiver’s expert did not claim that anyone at the bank actually ever did learn this information.

The Dissent

The Zayed case included a dissent, which vigorously argued that, viewing the evidence in the light most favorable to the Receiver – as required at the summary judgment stage – a jury reasonably could conclude that Sarles did far more than provide the fraudsters with ordinary banking services. Among other allegations, many of which are described above, the dissent emphasized the following:

  • Sarles held himself out to the fraudsters as a “friendly banker” who would help them avoid the unwanted scrutiny and compliance requirements of another bank, and therefore helped the fraudsters open several accounts in an alleged “repapering” effort that proved central to the Ponzi scheme after purportedly attending the investment pitch and the meeting to discuss the $13 million account shortfall and how to make an account with a balance of $2 million appear to contain $15 million;

  • Sarles was “an experienced banker who had received bank secrecy and anti-money laundering training[;]”

  • According to the Receiver, Sarles socialized with the fraudsters, by drinking, discussing business, and quoting movie lines which glorified greed.

  • Sarles helped Cook withdraw hundreds of thousands of dollars of investor funds for use inconsistent with the funds’ intended purpose;

  • Although Sarles testified that Cook informed him that one of these accounts would not hold investor funds, Sarles later approved Cook’s request to transfer $1.7 million of investor funds from the U.S. Crown Forex account to that account;

  • The signatory for one of these accounts performed general maintenance on one of the fraudster’s properties and had no substantive role in the business; and

  • Four of these accounts, opened within a three-month period, were named different variations of “Oxford” and had the same address.

Copyright © by Ballard Spahr LLP

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About this Author

Mary Treanor Lawyer Ballard Spahr
Associate

Mary Treanor focuses her practice on representing energy and commodity companies, financial institutions and trade associations in a variety of regulatory, compliance, litigation, and transactional matters. Her work includes representing clients in enforcement matters before the Commodity Futures Trading Commission, Federal Energy Regulatory Commission and Chicago Mercantile Exchange, as well as advising on regulatory matters and assisting with transactions.

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