Ponzitracker

A New York Bankruptcy Judge has rejected the latest attempt to hold a banking institution liable for its failure to detect a client's Ponzi scheme. In an order entered on August 3, Southern District Bankruptcy Judge Stuart M. Bernstein denied the bid by Sheila M. Gowan, the trustee for Marc Dreier's failed $700 million Ponzi scheme, to hold Wachovia Bank liable for failure to detect the scheme while it lent Dreier millions of dollars. According to Sheila M. Gowan, Wachovia was bound to investigate the "inklings" it began to have concerning Dreier's financial health:

Without Wachovia’s assistance, MSD’s fraud would likely have been revealed years earlier, thus preventing losses totaling hundreds of millions of dollars suffered by late investors in the scheme and other DLLP creditors. Wachovia was ideally-situated to discover the sources of the funds MSD was using to finance his lavish lifestyle while pursuing exponential growth at DLLP, yet Wachovia refused to ask the probing questions that it believed would cause Dreier to take its banking business elsewhere.

The lavish lifestyle Gowan refers to centers on Dreier's purchase of a $17 million luxury yacht using funds from a Wachovia account. Soon after the purchase, Dreier sought a $8 million loan from the bank using the newly-purchased yacht as collateral. The employee tasked with reviewing the request noted several abnormalities with Dreier's finances, saying she was unable to verify his income for several years and surmising that Dreier had misrepresented his business assets as personal assets. Further review by her superiors supported this observation, with Wachovia's national managing director saying that Dreier's cash flow "doesn't add up."

Despite these "inklings," Wachovia made the loan, and in the following year, allegedly violated numerous Wachovia internal banking procedures to accomodate various requests by Dreier, who by then was one of the firm's most valuable clients. According to Gowan, Wachovia knew or should have known that this loan was going to be used to repay investors in Dreier's scheme.

Under the trustee's legal theories, Wachovia can be held liable if it had actual or constructive knowledge of Dreier's fraud. While Gowan did not allege that Wachovia had actual knowledge of the fraud, she argued that the weight of evidence and "inklings" should have alerted Wachovia to Dreier's fraud. Echoing the difficulty of succeeding under such theories, Judge Bernstein concluded that Wachovia did not have actual or constructive knowledge of Dreier's fraud and granted Wachovia's motion to dismiss. In her opinion, she concluded that:

While Wachovia may have had reason to question Marc’s honesty and the accounting for and source of all of the funds used by him and Dreier LLP, this does not add up to actual or constructive knowledge that (1) Marc was running a Ponzi scheme through Dreier LLP’s account at Chase, or (2) the October 2008 Loan proceeds were destined for a Ponzi scheme investor. Wachovia did not invest in the Ponzi scheme; it loaned money to Dreier LLP, a seemingly legitimate enterprise which, unlike Marc, apparently paid its obligations on time. The Complaint refers to only one overdraft, and does not attribute any late payments or defaults to Dreier LLP. Further, Marc did not run his fraudulent scheme through Wachovia. Thus, the inflow and outflow of funds connected with the Ponzi scheme transactions would not have come to Wachovia’s attention or sounded any alarms.

Additionally, because Wachovia received new value for the loan it made to Dreier - the securing of the yacht as collateral - Judge Bernstein rejected Gowan's claim that the loan could be avoided under fraudulent transfer laws. Gowan was, however, permitted leave to refile her claims concerning preferential transfers.

Wachovia is the latest banking institution to prevail against claims that it was under a duty to detect a client committing fraud. Judge Jed S. Rakoff recently dismissed claims in the Soutnern District of New York brought by the trustee of Bernard Madoff's massive Ponzi scheme alleging HSBC ignored "red flags" and aided and abetted Madoff's crimes.

A copy of the Complaint is here.

A copy of Wachovia's Motion to Dismiss is here.

A copy of the Order dismissing the trustee's claims is here.