A recent Northern District of Illinois case concerning fraud against investors alleges causes of actions against the financial institutions where the investors' funds were being held. This case poses an interesting question as to whether financial institutions should have a heightened duty to monitor bank accounts that are known to be customer segregated accounts.
In In re: Peregrine Financial Group Customer Litigation, 12-C-5546, the plaintiffs are a class of customers of the Peregrine Financial Group, a futures commissions merchant. Plaintiffs allege a twenty year scheme of fraud and concealment by Russell Wasendorf, Sr., the founder of Peregrine, whereby Wasendorf would take funds from Peregrine's customer accounts located at US Bank and use the funds for his own personal use and gain or to cover Peregrine's business expenses. Funds looted included multi-million dollar transfers from customer segregated accounts at JPMorgan to bank accounts at US Bank. Wasendorf's fraud scheme involved intercepting mail sent to US Bank by his auditors or the National Futures Association ("NFA") and then forging responses to fool his auditors or the NFA. Wasendorf would also forge US Bank statements and other documents that reflected the balances in his U.S. Bank accounts. Using the forgeries, Peregrine convinced the NFA that it had over $200 million dollars in its bank accounts when it in fact had only $5 million.
Plaintiffs' primary theories of liability against US Bank and JPMorgan are breach of fiduciary duty and negligence. In essence, plaintiffs allege that the financial institutions had a heightened duty because they knew that the accounts looted were customer segregated accounts and thus they should have been monitoring those accounts more closely. Plaintiffs argue that the transfers between Peregrine's customer segregated and Peregrine business related bank accounts at US Bank and the transfers ranging from $5 million to $10 million from JPMorgan to US Bank should have triggered red flags at both institutions. In response, US Bank and JPMorgan sought a motion to dismiss arguing that banks are not regulators and cannot guarantee that their customers are not performing illegal activities. They further argue that the law does not require banks to be regulators and with millions of customers, it would be impractical for banks to assume such as role.
Although the failure here would seem to belong to the auditors, who relied on Wasendorf's forged correspondence and bank statements and failed to recognize the fraud, an argument can be made that had red flags been raised at the institutions where the multi-million dollar transfers from customer segregated accounts occurred, the fraud could have been detected much earlier. Banks already have anti-money laundering duties pursuant to the PATRIOT Act. A similar requirement for suspicious customer segregated account transfers could have alerted the NFA of potential fraud by investment institutions. However, as these requirements are not law, it is unlikely that the plaintiffs will be able to recover from the financial institutions.