By: Andrei Girenkov
Bernie Madoff’s $17 billion dollar Ponzi scheme may go down as the largest of its kind in history. The man himself will spend the rest of his life in federal prison. SEC has doled out punishments to eight employees who should have uncovered the fraud earlier. But none of that will compensate the victims for their loss.
The man appointed by the SEC to carry that responsibility is trustee Irving Picard. Picard so far has recovered over $7.6 billion for the victims of the fraud. The vast majority of this money came from a ‘clawback’ settlement with Jeffry Picower, an early Madoff investor who was able to withdraw his profits before the scandal came to light. ‘Clawback’ laws allow victims of a Ponzi scheme to sue other winning investors for return of their profits, even if the other investors were innocent beneficiaries of a seemingly legitimate investment plan. Other investors sued by Picard for return of their gains have not been so cooperative.
In addition to clawback lawsuits, Picard has filed a $20 billion lawsuit against JPMorgan Chase (JPMC) and UBS banks, which he claims collected over $1 billion by servicing Madoff’s accounts and facilitated the fraud through their negligence. Unfortunately for Madoff’s victims, U.S. District Judge Colleen MacMahon dismissed Picard’s suit earlier this month citing his lack of standing to sue for common-law negligence.
Two investors, Stephen and Leyla Hill, took up the torch last week by filing a lawsuit against JPMC in the Southern District of New York on the same grounds. They are seeking class certification to represent all investors defrauded by Madoff.
If the class action is certified and survives the initial motions to dismiss, the Hills have an uphill battle to establish the JPMC’s liability. A bank has no fiduciary duty to non-customers. Recently however some courts have recognized a duty by banks to foreseeable non-customer victims to exercise ordinary care to prevent fraudulent use of accounts. For an example of liability under this theory involving identity fraud see City Wide Paving, Inc. v. M & I Marshall & Isley Bank, 2011 WL 3207045 (S.D.Ind.).
Additionally, banks are obligated by the Bank Secrecy Act of 1970 (BSA) to maintain anti-money laundering compliance programs. Under the act, banks must investigate transactions over $10,000, and when red flags are discovered, banks are obligated to close the accounts and file a Suspicious Activity Report (SAR) with the authorities. Compliance programs often include a “Know Your Customer” protocol where banks verify the business and source of income for funds regardless of individual transaction amounts.
The plaintiffs will undoubtedly argue that JPMC ignored red flags that could have uncovered Madoff’s fraud years earlier, saving investors billions of dollars. According to Madoff’s 2009 court testimony, he “used the money in the Chase Manhattan bank account that belonged to [the client]or other clients to pay . . . requested funds.” Withdrawals over the $10,000 BSA limit would have required an investigation and filing of an SAR by the bank.
Case law on the BSA is relatively immature. If JPMC complied with the reporting requirements, the plaintiffs still may attempt to prove liability by showing that the bank had actual knowledge of the fraud or that it was negligent in its monitoring despite complying with the letter of the law. The court’s decision on these key issues will shed much needed clarity to banking industry litigators and compliance departments. It is regretful that advances in anti-fraud law are often carried on the shoulders of the victims.
