Showing posts with label banks. Show all posts
Showing posts with label banks. Show all posts

Friday, September 15, 2023

£5.41m reg fine over energy traders' WhatsApps cautions attorneys also on retention, spoliation, FOI

Electrical pylons on the Leeds-Liverpool Canal, England.
Mr T via Geograph CC BY-SA 2.0
The British gas and electric regulatory authority (Ofgem) fined investment bank Morgan Stanley £5.41m in late August for failure to record and retain traders' messages on WhatsApp.

News of the fine has shaken up the British compliance sector. The case should grab the attention of compliance attorneys, of course, but also corporate counsel and government attorneys throughout the Anglo-American legal system.

Wholesale energy traders discussed market transactions on WhatsApp on their personal devices. Rules on market manipulation and insider trading require that communications "relevant" to trading be documented and retained for Ofgem review; the messages were not.

The enforcement action therefore represents a wake-up call, but not a new standard. The case probably resonated for two reasons. First, employee use of personal devices for communication is increasingly common, if not expected, and it's difficult to police. Second, WhatsApp is known for its end-to-end encryption, a feature that makes it appealing to users, but incompatible with regulatory transparency.

I'm not a fin reg wonk, but it was those characteristics of the case that caught my attention. The enforcement action should remind corporate counsel that record retention requirements cut across devices and applications and can even follow employees home. Moreover, when records might be perceived reasonably to have potential relevance in future litigation, the cost of non-retention in spoliation can be steep.

Similarly, the enforcement action should remind government authorities that neither non-public location nor software-driven encryption countermands record retention and freedom-of-information laws. Transparency law was once vexed by problems such as proprietary access and private location; it is no longer. Just ask Hillary Clinton about her State Department emails or Donald Trump about his bathtub war plans.

The enforcement action is Ofgem, Penalty Notice: Finding That Morgan Stanley & Co. International PLC Has Breached Regulation 8 of the Electricity and Gas (Market Integrity and Transparency) (Enforcement etc.) Regulations 2013 (the REMIT Enforcement Regulations) (Aug. 23, 2023).

Friday, February 17, 2023

Bank battles liability for client's pyramid scheme

The federal district court in Massachusetts has continued in recent months to resist Bank of America efforts to extricate itself from allegations of complicity in a pyramid scheme.

The liability theory working against Bank of America (BoA) in the Massachusetts litigation is a theory of ancillary, or secondary, liability.  I'm fond of ancillary liability theories, which put on the hook not just the actor that most directly injured a plaintiff, but the actor's compatriots.

by Zainabdawood77 via Wikimedia Commons CC BY-SA 4.0

The myriad ways an injured plaintiff can add defendants to a civil claim improve the plaintiff's odds of recovery. So it behooves the plaintiff attorney to think creatively about ancillary liability. Correspondingly, it behooves the defense attorney to be on guard.

A plaintiff can be especially in need of better odds when a principally responsible defendant acted criminally, because criminal defendants tend to come up short on money to right wrongs. Ancillary liability theories in cases of financial crime are especially compelling, because perpetrators of fraud, before they're apprehended, tend to live large on their proceeds and then declare bankruptcy.

Think Bernie Madoff. His wild ride merited a thrilling fictionalization starring Richard Dreyfuss and still drives public interest with a new docuseries on Netflix. That his victims tended to be wealthy adds a sweet note of schadenfreude for American viewers, the vast majority of whom are trapped on the wrong side of the wealth gap.

That same schadenfreude thirsts for the diffusion of liability to more defendants. Plenty of corporations, namely banks and investment firms, and their directors and officers, leached wealth off schemes such as Madoff's, but bear no liability to victims. Ostensibly, these earners did nothing wrong. They merely engaged in lawful business.

Overlay that dynamic on financial opportunism that victimizes ordinary people, and the thirst for accountability becomes about more than schadenfreude. Financial disasters such as the savings-and-loan crisis of the 1980s and the housing crisis of 2008 infused the public with burning resentments that still smolder in the wreckage of the American dream.

In these crises, people were victimized by risks that enterprise externalized while providing no corresponding benefits. When the civil justice system fails to recognize a wrong in the infliction of such losses, we can expect the very insults to the social fabric that the system is supposed to prevent: more wrongdoing, diminished confidence in public institutions, and, ultimately, vigilantism by the afflicted.

Ancillary liability rides to the rescue. Two liability theories are especially useful in cases of financial fraud: "conspiracy" and "aiding and abetting." Those imprecise terms are useful to convey the essence of it, but the civil theories should not be confused with their criminal counterparts, which give rise to the terms.

More accurate descriptions in civil terminology are, respectively, "common design" and "substantial assistance or encouragement." When a principal defendant cannot be held to account, a plaintiff may demand compensation from a co-defendant that participated in a tortious common design with the principal, or from a co-defendant that knowingly substantially assisted or encouraged the principal in accomplishing a tortious objective.

The availability of conspiracy and aiding-and-abetting liability theories in common law business torts is not settled and not without controversy. The commercial defense bar naturally regards theories derived from personal injury law as ill suited to business torts, in which harms are only economic. Commercial actors are expected to safeguard their own interests to some extent in commercial transactions, more than a person exposed to risk of physical injury. Compensating economic loss is not regarded as socially imperative as the making whole of injured persons. The issue offers a window into a broader debate over whether business torts are torts at all, or, rather, a form of common law market regulation. We can leave that question on the shelves of academia for now.

In multi-district litigation pending in the U.S. District of Massachusetts, plaintiffs allege that Bank of America, among other defendants, substantially assisted or encouraged a pyramid scheme, or, more precisely, a "multi-level marketing" scheme (MLM), in the provision of commercial banking services. Bank of America (BoA) vigorously denies the allegations. In August 2022, the court refused to dismiss BoA, finding the allegation of ancillary liability sufficient to warrant discovery. The court has refused to undo its ruling upon motions for reconsideration since.

The principal defendant in the case is Telexfree, a transnational company with U.S. headquarters in Massachusetts. Having started up in 2012, the multibillion-dollar enterprise was an MLM that enlisted "promoters" to sell voice-over-internet-protocol telecommunication services. For a deeper dive into the rank turpitude of MLMs, check out comedian John Oliver's classic treatment in 2016. True to form, after only a year or two, Telexfree collapsed in bankruptcy under pressure from regulators in various countries, especially the Securities and Exchange Commission in the United States and authorities in Brazil. Private civil suits followed.

There is no question that banks such as BoA literally "substantially assisted or encouraged" Telexfree in its illicit enterprise. A company, even an MLM, needs banking services. The tricky part, though, for plaintiffs successfully to allege tortious aiding and abetting, is to show the ancillary defendant's knowledge of the principal defendant's tortious objective. BoA denies that it knew what Telexfree was up to.

Such denials usually fly. Banks at least purport to do business at arm's length. That impression accords with the experience of the average consumer; we don't imagine bankers poring over our checking accounts to second-guess our spending. And there's a sound argument in public policy that banks should not be held liable for the misdoings of their clients. Imposing weighty responsibility on banks, at best, would slow down commerce, and, at worst, could render capital inaccessible, paralyzing the marketplace. 

At the same time, banks with large commercial clients, in fact, routinely do business at much less than arm's length. Banks may well scrutinize clients, indeed may be fiduciarily obliged to scrutinize clients, if their business will place large amounts of capital at risk. Accordingly, the pleadings in Telexfree indicate that BoA worked closely enough with Telexfree executives to know what they were up to.  Indeed, plaintiffs allege that at least one BoA executive voiced concern that Telexfree's business model was not legal, and evidence suggests that BoA closed at least one account for that reason.

Upon the pleadings, then, the district court ruled that BoA had enough "red flags" to know what Telexfree was up to. BoA objected, and the court conceded, that red flags do not equate to the actual knowledge required for aiding-and-abetting liability. But red flags are evidence enough to allow plaintiffs to dig deeper in discovery, the court concluded.

The ruling has caused some angst in the commercial sector, for fear of the slippery slope of bank liability. I respect the worry, but I welcome the court's fresh take and willingness to rebalance the equities in financial fraud. Madoff was a compelling curiosity, and I don't have much sympathy for his high-roller investors. But more troublesome in America are recurring financial crises that seem only to exacerbate wealth disparity. And at the transactional level, MLMs and their like continue to run rampant, defying regulators and bilking not just high rollers, but ordinary people. 

The rabble is restless, as accountability runs thin. Regulators, whether wearing black robes or bearing pointy heads, had better start noticing.

The case is In re: Telexfree Securities Litigation, No. 4:14-md-02566 (D. Mass. received Oct. 22, 2014). HT @ attorneys Anthony D. Mirenda, Leah Rizkallah, and Nick Bergara of Foley Hoag LLP, writing for Mondaq.

Tuesday, May 11, 2021

Court rejects qui tam suit against big banks because whistleblower relied on publicly available data

"Big Ballin' Money Shot" by Louish Pixel CC BY-NC-ND 2.0
A whistleblower alleged that a who's who of big banks is improperly manipulating the municipal bond market to profit at the expense of Massachusetts taxpayers.  But the Massachusetts high court today rejected the whistleblower's lawsuit because he relied on public data.

This case is of interest because it arises under, and narrows, a state false claims act.  With the federal government doling out billions of dollars in pandemic relief to corporate America, I've predicted, and it doesn't take a crystal ball, that we're going to see a rise in corruption and a corresponding rise in enforcement actions.  One key enforcement mechanism is a false claims act.  In anticipation of good work to be had for lawyers in the false claims vein in coming years, I added the subject this spring to coverage in my 1L Torts II class.

False claims cases, or "qui tam actions," allow any person, a member of the general public called "a relator," to bring a lawsuit on behalf of the government, that is, the public, to recover money lost to fraud or misfeasance.  Derived conceptually from Roman law and carried on in Anglo-American common law for centuries, "qui tam" is short for a Latin phrase meaning one who sues on behalf of the king and for oneself.  Relators are incentivized by being entitled to a cut of any recovery.  Qui tam is authorized in the United States by federal law (§§ 3729-3722, and at DOJ) and the laws of many states (at Mass. AG), varying in their particulars, and also can be a part of sectoral enforcement mechanisms, especially in healthcare and finance.

In the instant case, relator "B.J." Johan Rosenberg, an investment analyst and capital adviser with experience in municipal securities, alleged that banks are pricing municipal bonds and manipulating the market in ways that profitably breach their obligations to their public clients.  Defendants in the Massachusetts case include Chase, Citi, Bank of America, Merrill Lynch, and Morgan Stanley.

The Supreme Judicial Court (SJC) dug into the particulars, which make my eyes glaze over and remind me why I have a financial adviser.  Suffice to say that Rosenberg understands this stuff well.  In 2019, Bloomberg described him as the "mystery man behind $3.6 billion in muni lawsuits," referring to qui tam actions in California, Illinois, and Massachusetts.  In 2015, Bloomberg reported, Rosenberg patented "MuniPriceTracker," a software designed to "ferret out Wall Street chicanery."

Rosenberg's analytical software is key in the instant case, and there the problem arises.  The false claims act in Massachusetts law (§§ 5A to 5O), as in federal law, bars claims based on publicly available information, whether from government reports or "news media."  The theory is that a qui tam statute should incentivize whistle-blowing by persons privy to information that the government and public are not, rather than potentially rewarding someone who rushes to the courthouse with old information.  As the SJC put it: "Where the essential features of an individual's purported chicanery already have been illuminated, ... affording a private party an incentive to bring suit is unwarranted, as it would add nothing to the Commonwealth's knowledge[.]"

The tricky bit in the instant case is that Rosenberg ran his software analysis on publicly available data.  That sourcing disallowed his action.  The court reasoned: "[I]t suffices that other members of the public, albeit with sufficient expertise and after having conducted some analysis, could have identified the true state of affairs by conducting the same data-crunching exercise as did the relator, using the data publicly available on the [Electronic Municipal Market Access] website."

Well, maybe.  To me, the phrase, "with sufficient expertise" is working overtime in that reasoning.  Rosenberg's method is sophisticated enough to be patent-worthy.  I don't think the average taxpayer spends weekends crunching market numbers, however publicly available they are.  And there's no evidence that anyone's doing it at the AG's office, either.  I worry that this narrowing of false claims to exclude "sweat of the brow" extrapolation from public records ill equips society to respond to sophisticated corporate malfeasance that can be revealed only by equally sophisticated detective work.

But I've already confessed my ignorance of finance.  You can read the 36-page opinion and decide for yourself.  Or choose among the views of the amici: the CFA Institute and Taxpayers Against Fraud Education Fund supported Rosenberg, and the Greater Boston Chamber of Commerce and New England Legal Foundation supported the banks.

The case is Rosenberg v. JPMorgan Chase & Co., No. SJC-12973 (Mass. May 11, 2020).  Justice Dalila Wendlandt wrote the opinion, affirming the lower court, for a unanimous SJC of six justices.  She was an accomplished patent attorney before going on the bench.