This article is the first in a series, authored by WLJ Banking Law Team members Adrienne Baker and Charles Coleman.
In the last couple of years, Ponzi schemes hit the highest level in a decade. Earlier this year, Zachary Horwitz made headlines after he was sentenced to 20 years for bilking investors out of $650 million by peddling bogus licensing deals with HBO and Netflix. Horwitz, a 35-year-old actor with small roles in low-budget flicks, pleaded guilty to federal securities fraud and running a Ponzi scheme. A Ponzi scheme is a type of financial fraud that uses money from new investors to pay off earlier ones, the proverbial “robbing Peter to pay Paul.” The term comes from the 1920 swindler Charles Ponzi, but in recent years it has been associated with Bernie Madoff, the perpetrator of the largest financial fraud in history…so far. The rise of Ponzi schemes is not only risky for investors, but also for financial institutions that those bad actors may use to further their nefarious ends.
Who is liable when bank accounts are used in a fraud? This is the question pending before a number of courts in jurisdictions across the United States. One might think a scammer who stole millions (or billions) from investors would have a lavish lifestyle complete with extensive assets and impressive investments. But, this frequently is not the case. Ponzi schemes inevitably fail and, when they do, creditors call their notes that financed purchases of homes, cars, and other valuables. There is usually little left to pay what is owed to investors/victims. This leaves investors, and sometimes bankruptcy trustees and federal equity receivers, in the position of looking for other assets to liquidate. One such asset is claims against third parties who are alleged to have aided and abetted the scheme. Frequently, financial institutions are the prime target of such aiding and abetting claims.
You may ask, what is aiding and abetting? How is it different from conspiracy? Aren’t these criminal concepts? Good questions. Civil (meaning, non-criminal) conspiracy is a claim arising from an explicit or tacit agreement among two or more individuals to accomplish an unlawful or oppressive end by lawful means, or to accomplish a lawful end by unlawful and oppressive means. The key to civil conspiracy is the existence of an agreement. Though it need not be written, there must be some evidence of a joint purpose. Once established, the acts of one wrongdoer can be combined with the acts of another wrongdoer, both of whom become civilly liable for the entire loss. Civil (again, meaning non-criminal) aiding and abetting is similar to civil conspiracy, except it does not require proof of an agreement. In other words, the plaintiff has an easier job of attaching liability to a defendant. In jurisdictions that recognize a claim for civil aiding and abetting, courts generally require proof of four elements: (1) a duty owed by the primary wrongdoer, such as a fiduciary duty; (2) a breach of this duty; (3) aider and abettor’s knowledge of the breach by the primary wrongdoer; and (4) aider and abettor’s substantial assistance or encouragement in the wrongdoing. See? No agreement required.
Stay tuned for Part 2 of this article where we talk about how these claims typically play out for banks caught in the cross-fire.