Backed by unrealistically ambitious owners, well-intentioned business ideas that fail to meet expectations or become unsustainable regrettably often become full-fledged Ponzi schemes.  Today’s Growth Consultant, Inc. (“TGC”) represents an entity that faced the same fate.

TGC advertised to potential investors its expertise in building, acquiring, and monetizing online websites.  Investors paid an upfront fee to TGC to purchase, host, maintain, and market the investors’ websites in exchange for TGC’s guarantee that investors would receive a minimum rate of return in perpetuity on the revenues TGC generated from those websites.  TGC raised at least $75 million during a nearly three year period, but its business model proved unsuccessful—it failed to timely purchase and build the promised websites or generate the promised revenue to cover the guaranteed returns to investors.  Instead, TGC turned into a Ponzi scheme to sustain its failing business by paying early investors with money it raised from later investors.

TGC maintained its business bank accounts at Defendants Heartland Bank and Trust Company (“Heartland”) and PNC Bank, N.A. (“PNC”) (collectively, “Defendants”).  TGC banked with Heartland until October 2018, and with PNC thereafter until December 2019.  Defendants provided TGC with typical banking services, including deposit accounts, commercial loans and revolving lines of credit, ACH capabilities, and transfers into, out of, and among TGC’s accounts.

In a recent decision in PLB Investments LLC et al. v. Heartland Bank and Trust Co. et al., the Northern District of Illinois decided that various defrauded investors of TGC (“Plaintiffs”) did not set forth sufficient allegations to show actual knowledge of a Ponzi scheme or bad faith in support of various Illinois state law claims against PNC.  No. 20 C 1023, 2021 WL 5937152 (N.D. Ill. Dec. 15, 2021).  While different jurisdictions set varying thresholds for adequately alleging actual knowledge or bad faith, PLB Investments emphasizes the importance of analyzing these elements early on to determine whether a plaintiff has alleged sufficient facts on the pleadings.

I.    Procedural History of PLB Investments

Plaintiffs brought a putative class action against Defendants alleging that these financial institutions violated the Illinois Fiduciary Obligations Act (“FOA”) and aided and abetted TGC’s website services Ponzi scheme.  Defendants each filed a motion to dismiss for failure to state a claim.  The court granted the motion without prejudice for PNC, and denied the motion for Heartland.

Plaintiffs then filed an amended complaint.  Again, both Defendants filed a motion to dismiss for failure to state a claim.  The court issued the instant opinion, dismissing all claims against PNC with prejudice, but allowing Plaintiffs to proceed with their claims against Heartland.

II.    The Court Dismisses Plaintiffs’ Claims Against PNC, But Allows Claims to Proceed Against Heartland

Plaintiffs’ FOA and aiding and abetting claims require that they sufficiently allege Defendants had actual knowledge of the misappropriation of investor funds, or that Defendants acted in bad faith in failing to discover the misappropriation.

Plaintiffs initially alleged PNC had actual knowledge of TGC’s misappropriation from: (1) manual processing of investor wires, (2) manual processing of large payments from Kerri Courtright—TGC’s owner—for his personal benefit, (3) discharge of PNC’s know your customer, BSA, and due diligence duties, and (4) interactions with TGC and Courtright when processing both incoming and outgoing payments.  In Plaintiffs’ amended complaint, they added more allegations they contended show actual knowledge: (1) PNC’s receipt of SEC subpoenas, (2) TGC’s abrupt departure from Heartland to PNC for banking services, (3) Courtright’s request for an automatic transfer from TGC’s account to her personal account when the personal account balance dropped below $1,500, (4) the corporate analysis fee PNC charged TGC, (5) the ACH extensions and PNC’s related reviews of TGC’s financial statements and business model, and (6) TGC’s receipt of loans from distressed lenders that TGC commingled with investor money.

It was not the volume of the allegations but their lack of factual support that carried the day.  The court held that Plaintiffs did not adequately allege that PNC had actual knowledge of the scheme.  The court criticized the complaint for “improperly piling inference upon inference,” id. at *7, characterized the allegations as “should have known” facts regarding the possibility of a scheme, and emphasized that “there are many legitimate reasons” why TGC could have engaged in certain banking activity.  Id. at *8.  The court further dismissed Plaintiffs’ arguments that PNC’s actions amounted to bad faith because the amended complaint failed to allege sufficient facts showing PNC had acted in bad faith, encountered any glaringly alarming activity, or established anything other than “suspicious circumstances.”  Id.  Based on these findings, the court dismissed Plaintiffs’ claims against PNC with prejudice.

In contrast, the court held Plaintiffs adequately alleged their FOA and aiding and abetting claims against Heartland.  Based on Plaintiffs’ allegations, Heartland learned of TGC’s Ponzi scheme when TGC acknowledged at a meeting that it had used and would continue to use incoming investor funds to cover the shortfall between website revenue and investor payouts until the website revenues increased or TGC developed an alternative revenue stream.  The court rejected Heartland’s additional prudential arguments for dismissal, including that Plaintiffs usurped the authority of the receivership estate in a related SEC action, improperly sought double recovery, and would obtain inconsistent rulings between the class action and the receivership action.  Based on these findings, the court allowed Plaintiffs’ claims to proceed against Heartland.

III.    PLB Investments’ Impact

This decision highlights the importance of challenging the absence of facts to support the element of actual knowledge.  While the pleading requirements of actual knowledge—and bad faith in some circumstances—may vary across jurisdictions, it is one of the first, major lines of defenses for a bank holding a financial relationship with the business operating a Ponzi scheme.  Plaintiffs are unlikely to survive a motion to dismiss if they cannot allege sufficiently detailed facts plausibly showing that the bank had actual knowledge of the scheme, beyond mere suspicion of potential wrongdoing.

Of particular note here, the court rejected Plaintiffs’ efforts to impute actual knowledge deriving from the receipt of SEC subpoenas.  Plaintiffs argued that the SEC only opens an investigation where the facts suggest fraud, and therefore a subpoena requesting information about a bank’s customer should establish that the bank immediately had actual knowledge of fraud; however, the court rebuffed this theory, noting an SEC subpoena does not typically apprise the recipient of the underlying alleged conduct nor does it mean a violation actually occurred.  As the court succinctly noted, a “possible violation of federal securities laws cannot satisfy the FOA’s actual knowledge standard.”  Id. at *7.

Further, allegations merely suggesting impropriety by the principal in changing financial institutions “abruptly” or requesting large transfers are similarly insufficient to satisfy actual knowledge standards.  For instance, Plaintiffs here alleged that Courtright, as TGC’s owner, requested a large transfer from an account holding investor funds, which should have alerted PNC to Courtright’s misappropriation.  The court disagreed, quoting Crawford Supply Grp., Inc. v. LaSalle Bank, N.A. for the idea that “there are many legitimate reasons why a fiduciary might frequently move large sums of money on behalf of a principal.” No. 09 C 2513, 2010 WL 320299, at *7 (N.D. Ill. Jan. 21, 2010).

Lastly, providing banking services like ACH extensions and financial evaluations continue to be taken as an “improper[] focus on what [the bank] should have known, not on what it actually did know.”  2021 WL 5937152, at *8.  PLB Investments has followed the general trend in most jurisdictions that Ponzi litigation requires that Plaintiffs clearly and specifically allege knowledge—rather than suspicions—of underlying fraud.