After Fraud, Regulators Go After a Bank - A government action against TD Bank, brought in connection with a customer's Ponzi scheme, is noteworthy and rare

- By FLOYD NORRIS - October 3, 2013 - The New York Times

You can’t run a Ponzi scheme without a bank.

In such a scheme, money that is supposed to be invested is really used to line the pockets of the Ponzi promoter or to pay previous investors. A lot of money has to flow through bank accounts, and it flows in ways that differ from what the promoter tells investors is happening. Banks are in a unique position to notice what is going on before the money is all gone.

But it is extremely rare for a bank to face sanctions for not noticing.

The typical judicial attitude was expressed last year when the United States Court of Appeals for the 11th Circuit upheld the dismissal — before a trial or any discovery of evidence - of a class-action suit against Bank of America by investors who had lost money in a pyramid scheme run by a promoter named Beau Diamond.

Even assuming that the plaintiffs could prove that Mr. Diamond “engaged in atypical business transactions, such as numerous wire transfers unrelated to any legitimate business activity,” the appellate court ruled, that would not be enough. The allegations in the suit were insufficient to render “plausible” a conclusion that the bank had “actual knowledge” of what Mr. Diamond was doing, so there was no need for a trial.

See no evil, face no liability.

That is why a joint regulatory action filed last week by the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Financial Crimes Enforcement Network, a part of the Treasury Department, seems so noteworthy. TD Bank, an American subsidiary of Canada’s large Toronto-Dominion Bank, agreed to pay $52.5 million to settle accusations that it had helped a Florida lawyer named Scott W. Rothstein commit one of the more brazen Ponzi schemes of recent years.

It is not clear, however, whether this represents a new attitude on the part of regulators to try to force banks to pay attention to possible Ponzi schemes - just as the Patriot Act requires them to monitor possible terrorist financing - or whether it is an isolated response to a particularly egregious case. Certainly the regulators had evidence, much of it provided by Mr. Rothstein in an effort to minimize his sentence, suggesting that one or more bank employees knew they were helping him deceive investors.

If regulators do not go after banks, the banks are usually home free. Some bankruptcy trustees for collapsed Ponzi schemes have tried to sue banks to recover money for defrauded investors only to have judges rule that because the trustee is standing in the shoes of the fraudster, such suits are not permitted. But when investors try to sue the banks, they can run up against rules limiting class-action suits and a Supreme Court decision saying that only the government - not victims - can bring suits contending that a bank, or anyone else, aided and abetted a fraud.

The Rothstein Ponzi scheme was created by a lawyer who had burst onto the Fort Lauderdale scene, living large and making highly publicized charitable donations. His firm, Rothstein, Rosenfeldt & Adler, employed 70 lawyers. He was vice chairman of a Florida Bar Association grievance committee that heard ethics complaints against lawyers. He was named to a committee to advise on state judicial appointments.

And he put together a $1.2 billion Ponzi scheme, according to the federal charges to which he pleaded guilty.

His scheme involved persuading investors to put money into “structured settlements.” Supposedly, these were settlements of cases that involved complaints like sexual harassment. The companies, he explained, had agreed to pay money over time to his clients in return for their silence. Those clients would sell the right to the payments in return for an upfront payment from the investor. He assured the investor that all the money had in fact been paid into escrow accounts he administered.

He spread the profits of the Ponzi scheme around, according to the federal charges, using money to “provide gratuities to high-ranking members of police agencies in order to curry favors with such police personnel and to deflect law enforcement scrutiny.” Political contributions were made with the money “in a manner designed to conceal the true source of such funds and to circumvent state and federal laws governing the limitations and contribution of such funds.” He sponsored fund-raisers for, among others, Gov. Charlie Crist, Senator John McCain and President George W. Bush.

For their first wedding anniversary, in 2009, he and his wife, Kimberly, attended an Eagles concert, where Don Henley dedicated a song, “Life in the Fast Lane,” to them. That cost him a $100,000 charitable contribution.

He kept a lot of the money for himself. After he was arrested, the government seized his car collection, which included four Mercedeses, three Ferraris, three Corvettes, two Rolls-Royces, one BMW, one Bentley, one Hummer, one Cadillac, one Bugatti, one Maserati, one Lamborghini and one Ford.

And he couldn’t have done it without the help of his bank.

At the time the Ponzi scheme began, he was using a small bank, Gibraltar Private Bank and Trust. He later testified that he had “protection” from officers at that bank but that he was upset by the “amount of scrutiny we were getting from certain due diligence folks” at the bank’s headquarters. And as he began to persuade large investors, including hedge funds, to invest, some of them wanted him to use a larger bank to protect themselves from a possible bank failure while the bank held the money.

So he moved to Commerce Bank, which was later acquired by Toronto-Dominion. The Canadian bank kept Commerce’s slogan, “America’s most convenient bank.” Its systems generated warnings of suspicious activity, but the bank ignored them, thanks to an extremely cooperative bank officer, Frank A. Spinosa.

According to an S.E.C. suit filed against him last week, Mr. Spinosa falsely assured investors that only they could get money from accounts that he said held millions.

Mr. Spinosa’s lawyer, Samuel J. Rabin Jr., says his client “did not know about the fraudulent conduct perpetrated by Scott Rothstein” and “never purposefully acted in any way to advance Scott Rothstein’s many schemes.” In an interview, he painted his client as a salesman who did favors for an important customer who promised to introduce him to other people who could become big customers of the bank.

TD Bank initially disclaimed any responsibility, and it bitterly fought a suit filed by Coquina Investments, which lost more than $30 million in the scheme. The bank is appealing a jury verdict that ordered it to pay Coquina $67 million in damages, including $35 million in punitive damages. Mr. Spinosa cited his Fifth Amendment right against self-incrimination in refusing to testify in that case.

It later turned out that lawyers for TD had withheld evidence in the case and misled the judge in a number of instances. As punishment, the judge ordered the bank to pay Coquina’s legal fees.

The bank has since settled other cases filed by victims. Altogether, the mess has cost it $500 million, according to a report in The South Florida Business Journal, although the bank declined to confirm the figure. As a result of the bank’s payments, said Jordan Maglich, a Florida lawyer whose blog, Ponzitracker.com, follows such cases, “This is the first time I can recall that victims are getting 100 percent of their money.”

Mr. Rothstein is serving a 50-year prison sentence, and eight others have been sentenced to prison terms. Other cases are pending and Mrs. Rothstein will be sentenced next month after pleading guilty to charges she tried to hide $1 million worth of jewelry, including a 12-carat diamond ring, from federal marshals seizing her husband’s assets. She is expected to receive a prison sentence.

TD Bank says it has improved its procedures, which certainly seems appropriate. Perhaps, even if this case does not herald a wider crackdown by authorities, it will persuade other banks that ignoring signs of a Ponzi scheme is no longer a safe thing to do.

Floyd Norris comments on finance and the economy at nytimes.com/economix