Third Circuit: Securities Fraud Liability May Be Imputed To Employer Whose Employee Ran Ponzi Scheme On The Side

by Pepper Hamilton LLP

On February 22, 2013, in the precedential opinion in Belmont v. MB Inv. Partners, Inc., a unanimous panel of the U.S. Court of Appeals for the Third Circuit (Judges Anthony J. Scirica, D. Michael Fisher and Kent A. Jordan) reversed in part a ruling of the District Court for the Eastern District of Pennsylvania (Judge Berle M. Schiller). In an opinion authored by Judge Jordan, the Third Circuit held that plaintiff investors were entitled to a trial on the question of whether an investment firm, MB Investment Partners, Inc. (MB), was liable under federal securities law and a state statute for the fraudulent statements of an employee. The employee and senior executive, Mark Bloom, had pleaded guilty to criminal charges relating to a hedge fund-cum-Ponzi scheme that he ran and plundered outside the scope of his MB employment. The plaintiffs had all invested in the hedge fund, North Hills, L.P. (North Hills), based on Bloom’s fraudulent advice. MB promoted North Hills and managed certain investments in the fund, but did not know of, participate in or profit from Bloom’s fraud. The plaintiffs suffered substantial losses and MB ceased operations after Bloom’s scheme unraveled.

The plaintiff investors brought suit in the district court against MB, certain of MB’s officers and directors, Bloom, and others, asserting claims under Section 20(a) of the Securities and Exchange Act and SEC Rule 10b-5. They also alleged state law negligent supervision and fiduciary duty claims, and claims under Pennsylvania’s Unfair Trade Practices and Consumer Protection Law (UTPCPL). The District Court dismissed or granted summary judgment on all claims as to all defendants except Bloom, concluding that the plaintiffs and the other defendants were all his victims. Bloom defaulted and was not a party to the appeal.

Under the facts as reviewed by the Third Circuit, Bloom’s fraud was undisputed. The negligent supervision claims against the MB directors failed because the directors were not Bloom’s “employers” and, though the directors were aware of Bloom’s involvement in North Hills, they did not know or have reason to know about his fraudulent acts. Similarly, the claim for control person liability under Section 20(a) of the Securities Exchange Act failed because the plaintiffs were unable to point to any evidence that the MB directors participated in the fraud or were intentionally inactive in preventing it. The fiduciary duty claims failed either because the plaintiffs did not show that fiduciary duties existed as between certain defendants and plaintiffs, or that certain defendants had conflicts of interest in recommending the North Hills investment. Furthermore, as to an individual MB executive defendant, the District Court properly rejected the Rule 10b-5 claim for lack of scienter and the UTPCPL claims for failure to show deceptive practices by the executive or reliance by the plaintiffs.

However, the Third Circuit parted ways with the District Court on the Rule 10b-5 and UTPCPL claims against MB. The question of 10b-5 liability turned on whether Bloom’s undisputed fraud could be imputed to MB as Bloom’s employer. The Third Circuit reasoned that even though 10b-5 is a federal provision, the question of imputation under the rule is decided as a matter of state law. Pennsylvania’s imputation doctrine would apply if Bloom acted with the apparent authority of MB, even if his conduct was unauthorized and for his own benefit. According to the Third Circuit, that rule of liability is grounded in public policy whereby the person who should bear the risk of an agent’s fraud is the principal that empowers the agent, rather than an innocent third party.

The Third Circuit further reasoned that the imputation question turned on whether the “adverse interest” exception to the doctrine applied. That exception relieves a principal of imputed liability if the lack of benefit to the principal is sufficient to charge the third party with notice that the agent is not acting within the principal’s authority. The District Court had concluded that Bloom was outside of MB’s authority merely because Bloom acted for his own benefit, and also concluded that Bloom’s interests were sufficiently adverse to MB because the fraud ultimately destroyed MB. But the Third Circuit stated that an agent may still act with apparent authority vis-à-vis a third party even if the agent is acting solely in his own interest, and that the ultimate destruction of MB did not occur until after the plaintiffs were induced to invest in North Hills in the course of Bloom’s fraud. Thus, there remained a triable question of fact as to whether the manner in which Bloom marketed North Hills to the plaintiffs made it appear that he did so within the scope of his employment, thereby imputing Rule 10b-5 liability to MB. A similar imputation question remained for the trier of fact with regard to the UTPCPL claim against MB.

Thus, Belmont cautions businesses, and investment firms in particular, to exercise care in empowering their employees and agents. MB had no affirmative duty to discover Bloom’s fraud, but could have averted potential liability, and possibly its demise, by conducting diligence on the products Bloom offered. Although an extreme case, the decision demonstrates that employers may not be immune from an employee’s self-interested fraud, even if the fraud is unknown to the employer and harmful to the employer and its clients alike.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Pepper Hamilton LLP | Attorney Advertising

Written by:

Pepper Hamilton LLP

Pepper Hamilton LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.