White Collar Criminal Defense Group

Acting Associate Attorney General Tony West Highlights Federal-State Collaboration On Financial Fraud In Speech To NAAG

On Monday, Acting Associate Attorney General Tony West focused on high profile cooperation between DOJ and the states in remarks to the National Association of Attorneys General Winter/Spring Meeting in Washington, DC.  For the top law enforcement officers in most states, times are tough and budgets are tight.  Nonetheless, there is apparently no truth to the rumor that the gathered AGs responded by breaking into a chorus of Warren Zevon’s “Send Lawyers Guns and Money.”

West noted three areas of collaboration where DOJ and state AGs have been able to effectively pursue common enforcement priorities.  He pointed specifically to the efforts to fight financial fraud, particularly that arising out of the financial crisis of 2008, the joining by many states in the recently filed lawsuit against Standard & Poors, and the joint efforts between DOJ and the AG’s of Alabama and Louisiana in the Deepwater Horizon oil spill trial that began on Monday in New Orleans. 

West…sees opportunity for shared resources to create “a formidable force-multiplier when it comes to accountability and deterrence.”

On financial fraud, West pointed to the landmark Mortgage Servicers Agreement developed in cooperation with many AGs.  He also lauded the task force work done in the areas of mortgage fraud and other forms of financial fraud.  He didn’t go into great detail on those efforts but mentioned again the work on mortgage fraud cases, emphasizing that the increased cooperation including the sharing of resources and information has enhanced the ability to pursue these cases. 

Large scale cooperation on financial fraud cases has not been something we have seen a lot of in the past.  Many state AGs often lament the lack of resources within their respective offices to pursue white collar cases in general.  Accordingly, it would seem that there are few resources to share on the state side.  West, however, sees opportunity for shared resources to create “a formidable force-multiplier when it comes to accountability and deterrence.”  While some states might see their smaller level of resources as a weakness, West indicated that sometimes state authority allows such agencies to “be more nimble than” the federal government.  

Another example of collaboration cited by West was the civil lawsuit against credit rating agency Standard & Poors filed earlier this month.  The case involves allegations that S & P defrauded investors who lost billions of dollars in structured financial products by issuing ratings that were inflated and biased by S & P’s concerns about market share and revenues.  He cited to the fact that the lawsuit was complimented by 13 parallel state actions against S & P alleging similar misconduct. 

Finally, West discussed the Deepwater Horizon oil spill lawsuit and ongoing trial as a shining example of the “unique expertise, perspective and knowledge” that the state authorities “can bring to bear on a whole range of local, regional, national, and international issues we both confront – insights that can enhance our approach to complex threats or catastrophic events.”  In reference to the trial, West emphasized that “sitting with our Justice Department attorneys at counsel table will be attorneys from the AG offices of Louisiana and Alabama, with whom we’ve worked over the last two-and-a-half years to build our litigation case.”  He added that “The case the United States is presenting in that courtroom today is stronger because of our collaboration with Louisiana and Alabama and our work with the other Gulf States – Mississippi, Florida and Texas – as well.”  In making this point, West alluded to the $1 billion trust fund established by BP and the $4 billion in fines and penalties already recovered in the case.   

West closed his remarks with a statement of intention to “double-down on our cooperation in the area of financial fraud because there’s no question we are stronger standing together than apart and there are more individuals and organizations who have yet to account for the economic damage they have caused to our country.”  Of course for those in the financial industry it is important to keep in mind that if resources are allocated to back up this promise, it could mean more scrutiny from law enforcement authorities. 

For decades federal and state law enforcement authorities have engaged in large scale cooperation in pursuing the “war on drugs.”  In recent years, the political winds have not been as strong for continuing that substantial effort.  If resources are shifted from that effort to financial regulation and related matters, the picture of enforcement could change drastically. 

Second Circuit Affirms Denial Of Claims Filed By Bernie Madoff Feeder Funds Investors

On Friday, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of claims filed by Feeder Funds investors against Bernard L. Madoff Investment Securities LLC (“BLMIS”).  The opinion was rooted in the Securities Investor Protection Act (“SIPA”), 15 U.S.C. § 78aaa et seq., and held that, because none of the investors invested directly with BLMIS, the investors did not qualify as “customers” under the SIPA. 

…courts must narrowly interpret the customer status component of the SIPA and “the critical aspect of the ‘customer’ definition” is “the entrustment of cash or securities to the broker-dealer for the purposes of trading securities.”

The investors provided capital for two limited partnerships, Spectrum Select, L.P., and Spectrum Select II, L.P., which, in turn, invested into two hedge funds, Rye Selected Broad Market Fund and Rye Select Market Prime Fund, known collectively as “Feeder Funds.”  The Feeder Funds invested in BLMIS through securities accounts maintained only in the funds’ names.  The Feeder Funds made deposits and withdrawals from their BLMIS accounts, and, all accounts documentation, including account statements and trade confirmations, were received from BLMIS by the Feeder Funds.

The investors in the Feeder Funds had no direct financial dealings with BLMIS and no BLMIS account information or records identified them as investors in BLMIS.  As a result, after the Feeder Funds investors filed claims with the bankruptcy court, both the bankruptcy trustee and the bankruptcy court concluded that the Feeder Funds investors were not “customers” under the SIPA.  The investors appealed to the district court, which affirmed the bankruptcy court ruling and gave rise to the Second Circuit opinion.

The Second Circuit found that Section 78lll(2)(A) of the SIPA defines a “customer of a debtor” as someone “who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of a business as a broker or dealer from or for the securities account of such a person.”  The court also noted that courts must narrowly interpret the customer status component of the SIPA and “the critical aspect of the ‘customer’ definition” is “the entrustment of cash or securities to the broker-dealer for the purposes of trading securities.”  In re: Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 227, 236 (2d Cir. 2011).  The Feeder Funds investors, however, never entrusted their cash or securities to BLMIS directly and, as the Second Circuit observed, “fail to satisfy this ‘critical aspect of the ‘customer’ definition.”  The court also found no evidence that the Feeder Funds were BLMIS agents or that BLMIS somehow authorized the Feeder Funds to act on its behalf or exercise control over the Feeder Funds. 

The full text of the Second Circuit opinion can be found here.