Last fall, I wrote an article for Carolina Banker magazine excitingly titled “Bank Liability to Non-Customers in a Ponzi Scheme.” The crux of it concerns the potential liability to banks in Ponzi schemes and the precautions banks should take to mitigate that risk.

I was reminded of that article with last week’s announcement of a settlement in the Rothstein Ponzi scheme in Florida. Scott Rothstein was a flamboyant and apparently very successful attorney in Florida. However, his lavish lifestyle was fueled by a $1.2 billion fraud. He purported to sell shares in fake lawsuit settlements to investors while promising them huge returns on their investments. Needless to say, there were never any settlements, and he also was paying old investors with new investors’ money. The scheme began to unravel in 2009, and he was sentenced to 50 years in federal prison in 2010.

The real fight was just starting for the banks. Not surprisingly, many of the aggrieved investors sought to recover their losses from the deepest pocket around, Rothstein’s primary financial institution — TD Bank (TD). These aggrieved parties, which range from individual investors to hedge funds, alleged Rothstein could not have perpetrated the fraud without the assistance (or, at the very least, the willful negligence) of TD. In fact, when questioned in a deposition, Rothstein testified that on a scale of 1 to 10, TD was a 10 in the amount of assistance it provided him in the fraud. In other words, he claimed TD was integral to the scam’s success. (Please note that TD denies any wrongdoing.) As referenced in my earlier article, TD’s alleged assistance in the Ponzi scheme was varied to include:
 

1. TD’s own money laundering software issued 21 “red flags” for the Rothstein accounts, but no suspicious activity report (SAR) was ever filed.
2. TD allowed Rothstein to meet his investors in TD conference rooms.
3. TD employees would provide letters, written by Rothstein’s office, on TD letterhead to Rothstein during said investor meetings.
4. Rothstein had regular overdrafts from his firm’s trust account, which, although illegal under Florida law, was never reported.
5. TD executives met with investors to underscore the safety of their investments.

To many it appeared that TD aligned itself with Rothstein and his investment scheme.

Apparently, the courts agreed. In 2012, Coquina Investments was awarded a $67 million verdict, which was later upheld in appellate court, against TD. And just last week, TD reached a settlement with New York hedge fund Platinum Investments in the amount of $44 million. With more than $100 million paid out, in addition to the damage to its reputation, this was an expensive relationship for TD. Although many lessons could be learned from this ordeal, I expect this is a relationship TD would like to forget.

Fortunately, the rest of us can learn from TD’s unfortunate situation without having to pay the same steep price:
 

1. Banks should endeavor to know their customers. However, it is impossible to know everything, including their intentions. Be alert and do not take anything for granted.
2. It is important to follow bank procedure and state law, regardless of the importance or prominence of the customer.
3. An SAR should be filed each and every time fraud is suspected on an account.
4. Customers are customers only. Banks should treat them well, without harboring the notion or acting as if they are in business together.

Rightly or wrongly, this story paints a picture in which TD crossed over from being a good bank partner for Rothstein to being a partner in and facilitator of Rothstein’s scam. Although good customers are highly coveted, especially in today’s market, banks must follow procedure regardless of potential consequences. Smoke usually indicates a fire, so a bank should not be afraid to cut a customer loose due to suspected fraud and wrongdoing. As my dad used to tell me, “A person is known by the company he keeps.”