After a Fraud, Regulators Go After a Bank

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 â€" before a trial or any discovery of evidence â€" 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 â€" just as the Patriot Act requires them to monitor possible terrorist financing â€" 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 â€" not victims â€" 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.

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