By Rodney F. Tonkovic, J.D.
JPMorgan had no control over Bernard Madoff's Ponzi scheme, a federal district court has found. The plaintiff investors accused JP Morgan, which provided banking services to Madoff, as being an indispensable part of his scheme. The court dismissed the claim with prejudice, finding that it was untimely, that JPMorgan exercised no control over Bernard L. Madoff Investments Securities LLC’s day-to-day affairs, and that the complaint failed to plead a primary violation of the securities laws (Dusek v. JPMorgan Chase & Co., September 17, 2015, Steele, J.).
Background. This action was filed by 38 investors taken in by the Madoff Ponzi scheme. According to the complaint, BLMIS had a continuous banking relationship with JPMorgan and held a series of linked direct deposit and custodial accounts there. One of these accounts, the "703 Account," received and remitted the majority of funds invested in BLMIS by Madoff's victims, amounting to approximately $150 billion over the course of the scheme. In other JPMorgan accounts, Madoff held the funds obtained through his scheme in government securities and commercial paper.
At various times in the late 90s and again in 2008, JPMorgan employees raised questions about BLMIS, but these concerns were not communicated to JPMorgan's anti-money laundering personnel. JPMorgan also never filed a Suspicious Activity Report until after Madoff was arrested. Among the activities that raised suspicion were a check kiting scheme in which JPMorgan allowed round-trip transactions to continue for several years and BLMIS's submission of false quarterly FOCUS reports.
Beginning in 2006, JPMorgan began to offer derivative products based on the performance of the Madoff feeder funds. There was significant demand for these notes, and JPMorgan's position in the Madoff feeder funds eventually created approximately $250 million in risk exposure to BLMIS. JPMorgan remained committed to its position in the Madoff funds despite mounting concerns about Madoff's purported investment strategy.
By late 2008, however, a JPMorgan due diligence analyst penned a memo describing, among other concerns, the inability of JPMorgan or the feeder funds to validate Madoff’s trading activity or custody of assets. During the same period, JPMorgan redeemed its positions in the Madoff feeder funds. No one involved in the redemptions informed anyone in JPMorgan's Broker/Dealer Group about their concerns about the validity of Madoff’s returns or even that the redemptions occurred.
Madoff was arrested on December 11, 2008. In 2010, the trustee for the liquidation of BLMIS filed a complaint against JPMorgan asserting both bankruptcy and common law claims, but the common law claims were dismissed for lack of standing. Subsequently, a class action asserting nine claims under common law was brought against JPMorgan. In early 2014, JPMorgan entered into a global resolution in which it agreed to pay a $1.7 billion penalty for two felony violations of the Bank Secrecy Act and to pay $218 million to settle the class action. The class action included only net losers. As net winners, the plaintiffs in this matter were excluded from the settlement.
Controlling persons. The complaint alleged violations of the federal controlling persons provisions and RICO, as well as a number of claims under state law. In count one of the complaint, the plaintiffs alleged that JPMorgan controlled Madoff and BLMIS. The court, however, found that this claim was untimely because the complaint was filed on March 28, 2014, well after the expiration of the five-year statute of repose on December 11, 2013.
JPMorgan argued further that it did not control BLMIS or the Ponzi scheme as a matter of law. According to the plaintiffs, JPMorgan had complete control over Madoff because its banking services, which could have been terminated at any time, were indispensable to his scheme. These allegations, the court said, were insufficient to show that JPMorgan had power over BLMIS's general, day-to-day affairs, or any direct or indirect influence over its corporate policies. Moreover, there were no plausible allegations as to why JPMorgan would involve itself "in Madoff’s inevitably doomed Ponzi scheme in order to earn routine banking fees," the court remarked.
No actual damages. As an additional reason to dismiss Count One, the court found that the compliant failed to plead that the investors suffered actual damages. In this case, the plaintiffs were net winners, meaning that they withdrew funds from BLMIS that exceeded their initial investments and subsequent deposits. In other words, the plaintiffs suffered no actual pecuniary loss. A lack of actual damages is fatal to a fraud claim under Section 10(b), and a primary violation is an essential element of a controlling person claim, the court said.
RICO. Finally, the court dismissed the plaintiffs' claims asserting a violation under RICO for JPMorgan's knowing participation in Madoff's racketeering enterprise. This claim, the court explained, was barred under Section 1964(c) because the conduct giving rise to the claim amounted to securities fraud. Here, the plaintiffs alleged mail and wire fraud, which, the court said, was integrally related to the purchase and sale of securities.
The court accordingly dismissed with prejudice the complaint's federal law claims. Having dismissed these claims, the court found no independent basis for jurisdiction over the plaintiffs' state law claims and dismissed them without prejudice.
The case is No: 2:14-cv-184-FtM-29CM.