November 13. 2020 – Heinert v. Bank of America, N.A., 2020 WL 6689287 (2d Cir.)

On November 13, 2020, the United States Court of Appeals for the Second Circuit issued an opinion in Heinert v. Bank of America, N.A. imposing a heavy pleading burden upon plaintiffs seeking to sue banks for the facilitation of a Ponzi scheme.

As the recession deepens, Ponzi schemes that benefitted from a thriving pre-pandemic economy are likely to collapse. While investors may pursue claims against the fraudsters themselves, these suits are unlikely to yield meaningful recovery as Ponzi schemes are frequently operated by judgment-proof shell entities. As a result, investors may look to deep-pocketed financial institutions to recoup their losses. Indeed, banks are a frequent target of Ponzi-scheme related aiding and abetting claims. These claims can present significant exposure risks to banks if they survive a motion to dismiss. Heinert shields banks from some of those risks by setting a high bar for pleading a key element of an aiding and abetting claim—actual knowledge of the underlying scheme.

I. The Facts of Heinert

In Heinert, a Ponzi scheme collapsed, prompting a group of defrauded investors to file suit against the individuals that perpetrated the scheme and the banks that opened and maintained accounts for those perpetrators. The plaintiffs alleged that bank employees helped sustain the scheme by lifting automatic, multi-day holds on large deposits and making false representations to a credit card company on the fraudsters’ behalf. Based upon this conduct, the plaintiffs pursued three theories of liability against the banks—aiding and abetting fraud, aiding and abetting breach of fiduciary duty, and conspiracy. The district court dismissed the claims and the plaintiffs appealed to the Second Circuit.

II. The Second Circuit’s Decision

An Aiding and Abetting Claim Requires Actual, Not Constructive, Knowledge

To make out an aiding and abetting claim in New York, a plaintiff must allege that a defendant had actual knowledge of the underlying wrong it purportedly facilitated. In some jurisdictions, constructive knowledge or inquiry notice of the primary violation may suffice to establish actual knowledge. In Heinert, the Second Circuit confirmed that constructive knowledge is insufficient to establish actual knowledge.

The Court strictly applied this rule, rejecting plaintiffs’ argument that certain red flags relating to atypical banking procedures or account irregularities gave rise to an inference of actual knowledge. Indeed, in evaluating the aiding and abetting fraud claim, the Court found that nothing short of actual knowledge of the specifics of the scheme to defraud would give rise to an inference of actual knowledge on the bank’s part. Accordingly, the “red flags” alleged by plaintiffs, including a bank employee’s receipt of a bribe in exchange for making certain misrepresentations to credit card companies, did not support a finding of actual knowledge since the bribe did not inform the employee of the underlying Ponzi-scheme. Nor did flags placed on the subject accounts for suspicious banking activities constitute actual knowledge, since the bank’s own investigation did not yield any evidence of a Ponzi scheme. Because the investors failed to plead facts showing that bank employees had knowledge of the specifics of the scheme, they failed to state a claim for aiding and abetting fraud and the Second Circuit affirmed dismissal of this claim.

Likewise, the Court found that plaintiffs failed to allege that the banks had actual knowledge of the breaches of fiduciary duty they purportedly aided. Plaintiffs claimed that the perpetrators of the Ponzi scheme breached their fiduciary duties to investors by misrepresenting investments and commingling funds. However, the investors’ complaint did not assert that the banks had knowledge of the fraudsters’ misrepresentations or that the offering materials for the investments imposed a commingling restriction. The Second Circuit found those omissions fatal to the investors’ aiding and abetting claim, reasoning that “a depository bank has no duty to monitor fiduciary accounts maintained at its branches in order to safeguard those accounts from fiduciary misappropriation.” To establish actual knowledge of the breach of the fiduciary duty, the Court held that plaintiffs would need to show that the commingling was unauthorized and that the bank was aware of this lack of authorization. Since the plaintiffs did not allege that the bank knew the commingling was unauthorized, it failed to establish actual knowledge of the fraudsters’ breaches of fiduciary duty, and dismissal was warranted.

B. Conspiracy Claims Also Require Allegations of Actual Knowledge

Like aiding and abetting claims, conspiracy claims require actual knowledge of a corrupt agreement. The Court noted that the plaintiffs did not allege that there was a “conspiratorial agreement between the Banks or their employees and the Individual Defendants pertaining to the underlying fraudulent scheme.” As in the aiding and abetting claims, the Court found the actual knowledge allegation “wanting” and held that the conspiracy claim must fail for this reason.