“Spotlight on Financial Crime:
Tracking Global Trends and Typologies”
Friday, November 4 ƒ 8:45AM – 9:45AM
Michael Diaz, Jr.
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Bank Liability for Customer Fraud
• Bank Secrecy Act provisions (31 U.S.C. §§ 5311-5330)
impose a duty on banks to fight fraud.
ƒ Under the BSA, all banks must maintain AML
compliance programs – internal policies and
procedures designed to safeguard against
1.
2.
3.
4.
5.
Money Laundering
Tax Evasion
Narcotics Trafficking
Terrorist Financing
Ponzi Schemes
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Bank Liability for Customer Fraud
• To comply with BSA requirements, a bank’s internal
compliance program must include “Know Your
Customer” (KYC) protocols.
• KYC procedures require banks to –
ƒ Verify the business and source of funds that enter
a business account;
ƒ Actively monitor customers’ accounts and
determine the legitimacy of transactions to and
from those accounts.
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Bank Liability for Customer Fraud
• KYC further requires banks to actively monitor their
customers’ accounts and determine the legitimacy of
transactions to and from those accounts.
• If a transaction is deemed suspicious, banks are
required to report the transaction, file a suspicious
activity report (SAR), and close the account.
• Failure to follow KYC procedures makes a bank
vulnerable to both civil and criminal liability.
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Bank Liability for Customer Fraud
• In case after case, banks are being sued under the
BSA and related regulations for having overlooked
the “red flags” associated with customer fraud.
ƒ Failure to verify the sources of money pouring into
previously illiquid accounts.
ƒ Blind acceptance of customer statements regarding the
origin and destination of hefty fund transfers between
related accounts.
• These omissions are now forming the basis of a new
theory of civil and criminal liability – one toward
which courts are highly sympathetic.
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Bank Liability for Customer Fraud
• Lawsuits by Irving H. Picard, the court-appointed
trustee of swindler Bernard Madoff’s seized assets:
ƒ Picard v. JPMorgan Chase & Co., No. 10-AP-4932
(Bankr. S.D.N.Y. 2011)
o Suing JPMorgan Chase for $1 billion in fees and an additional
$5.4 billion in damages, accusing it of “aiding and abetting
Madoff’s fraud” during its “decades-long role” as Madoff’s
primary banker.
ƒ Picard v. HSBC Bank PLC, Nos. 11-cv-0763 (JSR), 11-cv-0836 (JSR)
(S.D.N.Y. 2011)
o Suing HSBC for twenty-four counts of financial fraud and other
misconduct, and seeks to recover from it “at least $9 billion” in
addition to unspecified punitive damages. Picard claims that
HSBC, while marketing Madoff’s funds overseas, was “willfully
and deliberately blind to the fraud.”
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Bank Liability for Customer Fraud
• Smaller banks are also susceptible to be sued.
ƒ Razorback Funding, LLC, et al. v. Scott W. Rothstein, et
al., No. 09-062943 (07) (Fla. 17th Cir. Ct. 2009)
o Smaller doesn’t mean safer – local credit unions and savings and
loans are just as likely to be sued as their global counterparts.
o Pending class action lawsuit against TD Bank and Gibraltar
Private Bank of Coral Gables, Florida.
o These small banks are being accused of violating their own
compliance procedures, “blindly authorizing” a number of
suspicious wire transfers, and disregarding “apparent fraud
warning signs” regarding the accounts of Scott Rothstein, a
disgraced Fort Lauderdale attorney who recently pleaded guilty
for defrauding investors in a $1.2 billion Ponzi scheme.
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• Thomas Sterling is a prominent member of the
community.
• He runs his own financial consulting practice.
• Mr. Sterling offers clients the opportunity to
invest in certain financial products with a
guaranteed high rate of return.
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• Mr. Sterling assures his investors that he can
secure returns on investment that exceed the
normal rate of return.
• In addition to his success in business, Mr.
Sterling is a religious leader in his community.
• He hosts weekly “seminars” for fellow church
members on how to invest funds and how to
grow wealth.
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• Mr. Sterling tells his students that he wants to
share what he has learned with others so that
they can make a little bit of extra money each
week.
• Over the years, his students have also become
his investors.
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• For several years, Mr. Sterling has maintained
his business accounts at Ace Bank in Miami.
• In December 2010, Ace Bank notified Mr.
Sterling that it would close all accounts related
to his business, “Bright Futures Investments,”
because several recent transactions were
deemed suspicious.
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• Ace Bank could not reconcile the volume and
amount of transactions flowing through its
accounts with what it knew about Mr.
Sterling’s business.
• Mr. Sterling did not contest Ace Bank’s
allegations and after learning about the bank’s
decisions he transferred all his business
accounts to the Best Bank of Miami.
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` Mr. Sterling explained to a Best Bank
representative that he was moving his accounts
because Ace Bank was not business friendly.
` He needed a bank that understood the nature of
his business and the amount of money it
generated.
` Best Bank of Miami ignored several of its most
basic “Know Your Customer” requirements.
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• Best Bank of Miami knew that Mr. Sterling
was a professional business advisor who was
investing his client’s money.
• A simple inquiry would have revealed that
both Mr. Sterling and his company were not
properly licensed as broker-dealers or had any
securities or investment related licenses.
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• Days after Mr. Sterling opened his accounts,
several investment clubs associated with
Bright Future Investments opened accounts at
various Best Bank of Miami branches.
• Within weeks, 36 investment club accounts
had opened at Best Bank of Miami.
• Mr. Sterling’s sister, wife, and best man at his
wedding were included among those who
opened an account.
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• In the first month, these investment club
accounts transferred $2.2 million to various
accounts owned by Bright Futures Investment.
• Also within the first month hundreds of
thousands of dollars in cash belonging to
individual investors were deposited into the
new investment club accounts at Best Bank.
• Monies were then transferred to Mr. Sterling’s
business account.
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` Also within this time period, $140,000 in cash
was directly deposited into a Bright Futures
Investments account.
` Best Bank also permitted Mr. Sterling to
withdraw $235,000 from accounts which Best
Bank knew belonged to investors and not to Mr.
Sterling personally.
` During this time period, Best Bank failed and
refused to file cash transaction reports with
respect to any of these cash transactions.
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• Moreover, Best Bank even made special
accommodations for Mr. Sterling’s
extraordinary cash withdrawals by agreeing to
deliver large amounts of cash through the
drive-thru window in order to reduce the risk
of theft from having Mr. Sterling or an
employee walk out of the branch carrying
large bags of cash.
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`Less than 6 weeks after the Bright Futures
Investments accounts were open, Best Bank
noted in internal documents that the activity in
one of the related investment accounts was
suspicious.
`Numerous checks from individuals for small,
dollar-even amounts, totaling $400,000 had
been deposited and then transferred directly to
the Bright Futures Investments account.
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• Rather than shut down the accounts and all of
the feeder investment club accounts, Best
Bank merely placed a freeze on the particular
investment club account.
• 4 days later, Best Bank unfroze the account
based upon a “Business Plan” that a Bright
Futures Investments employee faxed to the
bank.
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• The so-called “Business Plan” was
inconsistent with the prior transactions that
Mr. Sterling’s company completed.
• Best Bank subsequently closed most, but not
all, of the Bright Futures Investments accounts
and related investment accounts.
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Case Study Analysis
• Mr. Sterling’s bank clearly violated key provisions of
the Bank Secrecy Act by failing to report the
suspicious transactions that the bank’s own internal
documents confirmed were detected
• The bank – as well as its officers and employees –
exposed themselves to potential criminal liability.
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Case Study Analysis
• Banks’ first and foremost focus should be complying
with the Bank Secrecy Act.
• If it were established that the bank knowingly failed
to report the customer’s suspicious activity, the
penalties could be crippling.
• The consequences of a criminal prosecution are grave.
• The effect of arrests, indictments, and guilty pleas which
carry stiff financial penalties can jeopardize a bank’s
ability to continue operating.
• Negative publicity stemming from a criminal investigation
will severely undermine investor confidence and customer
retention.
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Case Study Analysis
• Best Bank will have affirmative defenses, such as –
ƒ Lack of knowledge
o Juries, not judges, are usually charged with resolving
questions of knowledge. Once the case goes to the
jury, a bank loses all ability to control its outcome.
ƒ Absence of a fiduciary duty
o Claiming absence of a fiduciary duty to non-customers
doesn’t imply that a bank can simply overlook its own
customers’ suspicious activities.
o If a transaction raises a red flag, the Bank Secrecy Act
compels the filing of a SAR regardless of the
circumstances surrounding the transfer. The failure to
do so could lead to criminal penalties.
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Ponzi Schemes: An Anatomy
• Definition: A type of investment fraud in which promoters make false or
misleading statements about their investment and/or investment strategy.
The money from new investors is used to fund redemptions, resulting in
shortfalls in funds available for the remaining investors.
– Promoters accept funds from earlier investors and misrepresent money from
subsequent unsuspecting investors as a positive return on investment to the
earlier investors.
– Shortfalls can result from misappropriation of assets, from honoring early
redemptions based on fictitious returns, or both.
– Ponzi schemes collapse when the promoter is unable to attract sufficient
new investors to honor escalating redemptions or cover the
misappropriation of assets.
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Origin: Named after Charles
Ponzi (1882 – 1949), a
flamboyant con man who
defrauded New York investors
by promising them a fifty to one
hundred percent profit through
unsustainable postal coupon
arbitrage.
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Ponzi Schemes: An Anatomy
Some Classic Tell-Tale Signs
• Unusually High Returns
ƒ Outrageously high profits that are “too good to be true” given the nature of the investments.
• Aggressive Sales Techniques
ƒ For example, advertising the personal testimonies of beneficiaries without reference to an
actual product or service.
• Unclear/Unorthodox Business Model
ƒ “Smoke and mirrors” where essential business information is withheld.
• Promises of “Guaranteed Returns”
ƒ All legitimate investments have a risk of loss.
• Excuses for Non-Payment
ƒ Promoters can execute clever, believable excuses after failing to pay on time.
• Refusal to Return Principal
ƒ Excuses are often made in response to delay or to encumber investor demands to withdraw
their investment.
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How the Scheme Spreads
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Ponzi Schemes: An Anatomy
Bernard Madoff Example
• Warning Signs can be Counterintuitive and are Not Always
Apparent
In the Madoff scandal, investors’ deception was exacerbated by the fact that
Bernard Madoff was a well-known, public, and widely trusted figure who helped
found NASDAQ, and whose prominent firm has existed for almost a half century
prior to its recent dissolution and fall from grace.
– Moderate, but not Outrageous Levels of Return
• Unlike classic Ponzi schemes, which offered initial investors outrageously high
levels of return, Madoff’s relatively modest returns – coupled with his positive
reputation – provided his investors with a false sense of security.
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Ponzi Schemes: An Anatomy
– Consistent Payoffs Resulting in 8 – 13% Annual Gains
• In every single quarter, Madoff’s investors received a steady but measured profit
above, but not significantly above, historic market returns.
• This should have alarmed astute investors because genuine investments incur far
greater levels of fluctuation and always have a risk of loss.
– Past Willingness to Cooperate with Regulators
• In his previous position as NASDAQ chairman, Madoff advocated for corporate
transparency and securities reform. He was known to be extremely cooperative
with SEC investigators and maintained good rapport with these overseers.
• In this way, Madoff and his firm did not fit the traditional stereotype of a Ponzi
promoter and managed to evade both regulatory and investor scrutiny.
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Ponzi Schemes: An Anatomy
Allen Stanford Example
• Like Madoff, Stanford’s Inculpable Profile Tends to Vitiate Suspicion
Sir Allen Stanford was a prominent financier, well-regarded philanthropist, and avid
sponsor of professional sports. He holds the distinction of being the first American to be
honorably knighted by the Commonwealth nation of Antigua and Barbuda, and has donated
millions of dollars to charitable organizations such as the St. Jude’s Children’s Research
Hospital in Memphis, Tennessee.
– Consistently High Returns on Investments and Deposits for 15 Years
• Between 1992 and 2006, Stanford International Bank (SIB) made consistently high returns
on Certificates of Deposit ranging from 11.5% in 2005 to 16.5% in 1993.
• Since 1994, SIB’s “diversified portfolio of investments” has never failed to hit targeted
investment returns in excess of 10%.
• In 2008, SIB experienced only 1.3% in losses while the S&P 500 and the Dow Jones
STOXX Europe 500 Fund lost an average of 40%.
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– SIB’s “Diversified” Investment Portfolio is Actually Illiquid
• A substantial portion of SIB’s portfolio was placed in highly illiquid
investments such as real estate and private equity.
• Only Stanford and CFO James Davis knew of the portfolios’ true contents.
• So far, Stanford has failed to account for $8 billion of investor funds that
SIB purportedly holds. Thus, approximately 90% of SIB’s claimed
investment portfolio resides in a “black box” shielded from any
independent oversight.
– Using False Data to Entice More Investment and Sustain Ponzi
Scheme
• According to the SEC, Stanford Group advisors have sold more than $1
billion of a proprietary mutual fund wrap program (SAS) by using false
performance data.
• These fraudulent sales have helped grow SAS from less than $10 million
in 2004 to over $1.2 billion this year, enticing financial advisors to reallocate their clients’ assets to SIB’s CD program.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
• Filing a Claim with the Securities Investor Protection Corp. (SIPC)
– The SIPC is a government-created institution that keeps a reserve to
pay investors who lose money with failed brokerage firms.
– There is a $500,000 per victim cap:
• $100,000 for all cash losses;
• $400,000 for loss of securities.
– Many of Madoff’s and Stanford’s victims are filing SIPC claims rather
than pursuing private lawsuits.
• It is unclear whether a fraud victim’s receipt of SIPC remedies or filing of a
SPIC claim can compromise his/her pursuit of other remedies.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
– DRT Tip: Alternatively, victims may sue fraudsters personally based
on•
•
•
•
•
Where the fraudster is personally located;
Where the fraudster’s corporations are located;
Where the fraudster’s assets are located;
A combination of the above; or
All of the above.
• Filing a Claim Against the Fraudulent Entity’s
Receivership Estate
– The court issues an order appointing a receiver over the estate.
• The order enumerates general and specific powers. The court will review
and consider the actions of the receiver as an equity judge and fashion
remedies on a case-by-case basis.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
• Filing a Claim against the Fraudulent Entity’s Receivership Estate
(Continued)
– The receiver has NO DUTY TO DO VICTIMS JUSTICE by ensuring
adequate restitution. It is therefore critical that the victims carefully
comply with all requirements and deadlines of the claims process.
• Under the jurisdiction of the court and the initial asset freeze order, the receiver
stands in the “shoes of the entity” to effectively pursue, collect, and recover all
available assets.
– A receiver will generally apply to the court to make distributions to the
victims once all claims against the receivership estate are determined
and an order is entered ascertaining claimants’ priority of receipt for
receivership estate assets and proposed distributions.
• Victims should trace their investment to establish a distribution priority, but the
receiver or SEC can unilaterally apportion the loss pro rata over all of the
investors. See SEC v. Credit Bancorp., 386 F.3d 438 (2004).
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
– The receiver will coordinate with the government with respect to
prosecution of any violations of law, potential asset forfeiture, and
disgorgement of profits from the fraudulent enterprise.
• Typically, an agreement exists between the receiver and a supervising court or the
government so that any proceeds from assessed fines, restitution, and disgorgement
are turned over to the receiver for distribution to the victims.
– “Winners” those who received a return of principal and interest after a
Ponzi scheme determination is made, are at risk of having the funds they
received being deemed a fraudulent transfer.
• Generally, the winner has the burden to prove that they received the funds for value
and in good faith in order to rebut a prima facie case for fraud upon receipt of
transfer. See 11 U.S.C. § 548(c).
• For victims who receive less than a full recovery with “clean hands” but having
received something, a receiver may review whether it can prevail under a
constructive fraud theory.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
• Filing a Claim against the Fraudulent Entity’s Receivership Estate
(Continued)
– The timing of when the fraudulent enterprise became insolvent and morphed
into a Ponzi scheme is critical to how far back a receiver will look to “claw
back” funds from the investors.
• Generally, courts will seek to treat the entire fraudulent enterprise as a constructive
trust for all the approved claimants and then use its equitable process to approve a
receiver’s plan that will provide for a pro rata distribution to the approved claimants.
• Filing a Claim against “Feeder Funds” and Other Third Parties
– Victims can directly sue the “feeder funds” that invested their clients’ assets
with the fraudulent entity.
– Victims can directly sue other independent brokers, agents, sellers, and
marketers of the fraudulent products.
• Caution: Arbitration, choice of law, and forum selection clauses may hinder such
causes of action.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
• Filing a Claim against “Feeder Funds” and Other Third Parties
(Continued)
– Victims can directly sue third party consultants, accounting and law
firms, banks, and insurance companies that have served the promoter if
they knew or should have known of the promoter’s Ponzi scheme.
• Filing a Class Action Lawsuit against the Promoter, and his/her
Entities and Subsidiaries
– Victims can join in a class action lawsuit as similarly situated claimants
against the Ponzi scheme’s promoter and/or its other corporate entities
and subsidiaries.
• Caution: If successful, this action typically forces a bankruptcy.
– Victims can also directly force the promoter and/or its entities and
subsidiaries into involuntary bankruptcy.
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Ponzi Schemes:
Victims’ U.S. Legal Remedies
•
Filing an Asset Forfeiture Claim
– Plaintiffs can sue for pieces of property, forcing the owners to explain how
they acquired and paid for them.
• If probable cause is established to show that the assets are subject to forfeiture due
to their status as criminal proceeds or instrumentalities, a judge can order the assets
to be seized prior to the filing of formal criminal charges.
•
Acquiring Restitution via Formal Criminal or Regulatory Complaint
– Victims can acquire limited restitution for their losses through
government agency settlements as part of the SEC’s criminal enforcement
measures.
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• Bernard L. Madoff Investment Securities, LLC ($65 Billion)
– In addition to the sensationalized criminal conviction and associated
regulatory enforcement actions, a number of private lawsuits have been
filed against both the receivership estate of Madoff’s firm and the feeder
funds through which victims’ assets have reached Madoff’s coffers.
– There are currently 160 pending lawsuits against Madoff’s receivership
estate and feeder funds.
• 19 of these pending lawsuits are separate Class Actions.
• Most of these lawsuits are being adjudicated in the federal court while a
sizable minority are in state court.
See generally Kevin LaCroix, The List: Madoff Investor and “Feeder Fund”
Litigation, last updated July 6, 2009.
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– DRT Tip: Litigation Strategy
• Since Madoff has already pleaded guilty to criminal charges, all of his assets
worldwide must therefore be disclosed.
• The best approach is to sue third parties under those circumstances – suing the
asset would not help.
– Calls for a U.S. federal bailout of Madoff’s victims have been dismissed.
• Sufficient legal remedies exist.
• Bailout will increase investor recklessness (moral hazard).
• Collectively, taxpayers stand to lose more than Madoff’s victims.
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• Stanford Financial Group (Alleged, $8 Billion)
– In February 2009, prior to Stanford’s arrest, the SEC alleged that
Stanford and his accomplices operated a “massive Ponzi scheme,”
misappropriated billions of dollars of investors’ money, and falsified
Stanford International Bank’s records to hide their fraud.
• The SEC further alleged that “Stanford International Bank’s financial
statements, including its investment income, are fictional.”
– There are currently 17 pending lawsuits against either the Stanford
Financial Group or the Stanford International Bank.
• So far, 6 of these pending lawsuits are separate Class Actions.
– One lawsuit alleges that SIB is “nothing but a highly leveraged hedge
fund” and the bank’s CDs “high ultra speculative junk bonds.”
• All U.S. suits are being adjudicated in federal court while a Canadian suit is
before the Queen’s Bench in Calgary, Alberta.
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•
Stanford Financial Group (continued)
– DRT Tip: Litigation Strategy
• Unlike Madoff, Stanford has NOT pled guilty. Therefore, his worldwide assets are
up for grabs. A victim’s residency and where the assets are found are key.
• Since SFG’s receiver has indicated that there are insufficient assets to pay back
all victims, bankruptcy is inevitable.
• Suing third parties, separately or in parallel, is another option.
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• Elliott Group (Real Estate Ponzi; Dominican Republic)
– The Elliotts, who are real estate developers, used plaintiffs’ money
to pay back earlier investors in a Dominican Republic resort, and to
fund shopping sprees and vanity projects.
• An initial offering brochure projected “60% total returns over 3 years”
and reassured investors that their investment “is as secure as the land
it’s built on,” and would be paid “on the calendar quarter, every 90 days.”
• The Elliotts enticed investors into time-share like agreements to buy
seasonal stakes in luxury suites. The proceeds would then be kicked
back to investors in preset quarterly payments.
• Despite raising $170 million, no projects were completed. Financial
records and Elliott Group CFO Greg Clark have diagramed the Elliotts’
scheme, showing how earlier investors were paid with proceeds from
new ones.
• Eugenio Curatola (Argentina)
– 1200 investors defrauded out of $33 million in FOREX Ponzi Scheme.
– Curatola has been sentenced to prison for his scheme.
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• “La Vuelta” (Venezuela)
– Like most Ponzi schemes, “La Vuelta” began as a marginally legitimate
factoring operation.
• After a major strike in the Venezuelan petroleum industry, many creditors of
the state-owned Petróleos de Venezuela, S.A. (PDVSA) stopped receiving
payment on their accounts.
• Freddy Manzano and his accomplices used their PDVSA connections to buy
up unpaid creditor accounts at a discount, generally at only 60% of their face
value, and make a profit by obtaining full payment on the accounts through
their PDVSA connections.
• Through connections with PDVSA employees, the schemers then obtained
payment in full on the accounts, i.e. “La Vuelta,” of up to 40%.
• Manzano paid the creditors in American dollars, allowing them to obtain a
large influx of dollars not otherwise available due to local currency controls
and exchange rates.
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– Manzano and his accomplices aggressively sought out investors in
Venezuela and Miami to obtain the significant capital necessary to
purchase the unpaid debts.
• Investors in “”La Vuelta” were offered high monthly returns on their investment,
generally at 12 – 24% in addition to principal.
• “La Vuelta” worked early on and the “successes” of early investors lured
additional investors, giving the scheme a legitimate countenance.
– After various PDVSA employees were accused of corruption, La Vuelta fell
apart and quickly became a classic Ponzi scheme where old investors were
paid with funds from new investors.
• Stanford International and Stanford Financial created a sham “promissory note” to
assist in the shelter of Manzano’s ill-gotten gains.
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