Who is liable when bank accounts are used in fraud? That’s a lawsuit question after Marin County Ponzi case

While the unwinding of the late Ken Casey’s large Ponzi scheme, covering dozens of North Bay income real estate properties and over 1,200 investors, continues in bankruptcy court, a separate legal battle is heating up between some of those investors and the bank hosting Casey’s business accounts.

An audit after Casey’s death in May 2020 and a subsequent Securities & Exchange Commission investigation found that the scheme left the Marin County resident’s investment firms,Professional Investors Security Fund and Professional Financial Investors, underfunded since at least 2015.

Rather than going to paying returns, some of the $350 million raised from investors was used to pay for lavish living, auditors concluded. The inquiries resulted in bankruptcy filings in mid-2020 by the two firms, sales of most of the properties in late 2021 for $436 million, and the sentencing of Lewis Wallach, the top surviving executive, in September 2021 to 12 years in prison for embezzlement of $26.7 million.

The separate legal battles come from four investors — Shela Camenisch, Dale Dean, Luna Baron and Eva King — who sued Umpqua Bank in federal court in August 2020, two months after the ruse was discovered. They are accusing the Oregon-based institution, whose Novato branch was where Casey’s firms did their banking, of “aiding and abetting” in the plot to shift funds from new investors to pay existing investors.

Named after 1920s postage-stamp speculator Charles Ponzi, this type of investment fraud in which later investors’ money is used to pay earlier investors and often the scheme organizers, according to the SEC. The plot requires new investments to keep it solvent.

Umpqua said in a statement that it does not comment publicly on cases currently in litigation.

The bank’s attorneys in this case, at McGuireWoods in San Francisco, asked the court in San Francisco twice to dismiss the case, rejecting the contention that the bank had “actual knowledge” of the Ponzi scheme or provided “substantial assistance” to the plot.

Both motions were denied, most recently on Jan. 20. But in his denial order, Judge Richard Sheeborg wrote that it was a “close question” on whether the plaintiffs could prove their case. Some details of the both sides’ depositions of bank and Casey firm executives remain under court seal or have yet to be filed.

On Feb. 8 , the four investors filed for certification of the case as an expanded class action. Umpqua has until the end of March to respond, and the plaintiffs to reply by the end of May. A federal court hearing on that is set for early June in San Francisco.

Attorney Linda Lam of Gibbs Law Group, the Oakland firm pursuing the class action, said one reason for wanting to bring more plaintiffs into the case is to simplify the recovery process for investors, a number of whom are retirees who invested significant savings in Casey’s ventures.

“A lot are looking to this lawsuit for further recovery, and that can only happen if this proceeds with class certification,” Lam said.

The 70 rental housing and commercial properties that were part of Casey’s portfolio were valued at the outset of the bankruptcy filing at $555 million but were sold for $436 million to cover outstanding financing payments and other debts. When all is resolved with the business dissolutions, investors are estimated to have lost as much as $100 million.

The Novato case underscores a major challenge the banking industry has been facing in the past two decades of high-profile Ponzi cases, notably Bernie Madoff’s $65 billion scheme discovered in 2008 and R. Allen Stanford’s $8 billion plot uncovered the following year. Both those cases brought lawsuits against banks that provided services to their businesses.

And Ponzi schemes have been uncovered at an increasing rate in recent years. Sixty such plots involving $3.25 billion were revealed by state and federal officials in 2019, the largest sum since 2010 and double what was found in 2018, NBC News reported based on data from website PonziTracker.

The years after the Madoff case saw an evolution of lawsuits by investors against depository institutions that handled the accounts, according to attorneys at Waller Lansden Dortch & Davis, writing for a Bloomberg banking industry report. An early legal approach was to challenge a long-held rule that banks generally don’t have a duty to protect noncustomers. In the Casey matter, that would be the investors clients.

That morphed into legal claims that banks involved “knowingly aiding and abetting the schemes,” but the burden of proof for that can be high, the attorneys wrote.

And other lawsuit tactics have included pointing to depository institutions’ duties under laws meant to curtail criminal syndicates and, in recent decades, international terrorism. Those include Bank Secrecy Act and anti-money-laundering rules such as required reporting of suspicious activity, including movements of money over certain thresholds, such as $10,000.

Despite the high evidentiary threshold overall, some cases result in bank settlements. Umpqua itself settled Ponzi-related lawsuits, for $30 million in 2010 and $11 million in 2019, according to Oregon news reports.

On a preventative basis, software providers are stepping up to bring the pattern-noticing and learning capabilities of artificial intelligence to monitoring a bank’s accounts for “red flags” of suspicious activity, that would be noted for review by the institution’s staff. The Umpqua lawsuit on the Casey accounts alleges that the bank didn’t follow up on warnings its software found.

Jeff Quackenbush covers wine, construction and real estate. Before the Business Journal, he wrote for Bay City News Service in San Francisco. He has a degree from Walla Walla University. Reach him at jquackenbush@busjrnl.com or 707-521-4256.