Running a bank is fraught with risk. Its loans could go bad, devolving into a pool of what is euphemistically called “non-performing assets.” East European hackers could steal its customers’ identities, and ultimately their money. A bank’s own investments could sour. As you probably know, the list goes on and on. But here’s another possibility: one of the bank’s burgeoning customers – the one that’s rapidly growing and generating a significant amount of revenue in fees and commissions – could be running a Ponzi scheme right under the chief operating officer’s nose.
If you are running a bank, watch out for that last one. Be aware of what your customers are doing and how fast they’re doing it. Be diligent and see if you can catch illegal behavior before it spirals out of control. But if you don’t, whatever you do, be sure not to make things up about what was going on in those accounts. TD Bank and its former regional vice president Frank Spinosa can tell you all about it.
Last month, the SEC settled an administrative proceeding against the bank that arose out of a Ponzi scheme operated by Scott Rothstein, a now disbarred attorney. From 2005 to 2009, Rothstein used his law firm to run a scheme through the sale of purported discounted settlements to investors. Rothstein claimed to represent plaintiffs who had reached confidential settlements to be paid out over time by large corporate defendants. Rothstein told investors (1) the “plaintiffs” were willing to sell their periodic payments to investors at a discount in exchange for one lump sum payment, and (2) the defendants had deposited the entire amount of the settlements into his attorney trust accounts. Rothstein first opened accounts at a bank in South Florida, and then at Commerce Bank, later acquired by TD Bank.
For a bank in such a position, Job One is to recognize this activity for what it is and, if appropriate, cut ties with the customer at the core of the scheme. This is not easy: first, these customers will not exactly announce their evil intentions. Second, even for ethical bank executives, it can be hard to say no to a steady revenue stream without hard evidence that their customers are up to illegal conduct in the bank’s accounts. But getting out ahead of this is important if the bank wants to avoid expensive litigation from investors who might claim – even without foundation – that the bank was reckless in not knowing about the scheme. Even without taking these affirmative steps, though, in any event do be sure not to misrepresent the situation to investors.
To get back to our story, by the end of October 2009, Rothstein could no longer make payments to investors and the scheme collapsed. According to the SEC’s complaint, Spinosa falsely represented to several investors that TD Bank had restricted the movement of the settlement funds held in attorney trust accounts for the exclusive benefit of the investors. Spinosa allegedly executed “lock letters” stating that TD Bank would distribute funds in the trust accounts only to the investor’s bank account designated in the lock letter. These representations were allegedly false, as Spinosa did not apply any procedures that would have restricted Rothstein from moving the money out of the trust accounts. Spinosa also provided false assurances (allegedly!) to two investors that certain trust accounts at TD Bank did in fact maintain the account balances that Rothstein represented to investors. In reality, the SEC claims, the settlements Rothstein sold to investors were fake and the purportedly “locked” accounts generally held no more than $100.
TD Bank has consented to entry of an administrative order finding that it violated Sections 17(a)(2) and (3) of the Securities Act: negligence-based claims. The bank has agreed to pay a $15 million civil penalty and to cease and desist from violating those sections in the future. Spinosa is litigating fraud-based claims in the Southern District of Florida.
Sara Kropf has more on this case at Grand Jury Target.