Article

Prime Bank Instrument Scams.

Type of Lawsuit:

Action by SEC against alleged scamsters for violation of anti-fraud provisions of US securities laws, for disgorgement of illicit profits, and permanent injunction against future violations.

Parties:

Plaintiff: SEC

DefendantlAlleged Scamsters: John Gallard; Adrian Gallard; The Aberdeen Group, Inc.

False Instruments:

Prime Bank Instruments, Prime Bank Standby Letters of Credit, and Prime Bank Guarantees.

Activities:

1) In Jan. 1993, an investor's pool paid US$ 7.2 million for US$ 10 million PB S/by LC on which investors lost US$ 1.35 million.

2) In Oct. 1993, Chau investors paid $250,000 as "performance bond" for purchase of PB securities on which entire amount lost.

3) In March 1994, October House Management paid a US$ 250,000 deposit on a US$ 500 million PB guarantee on which entire amount lost.

4) Later, Chabafy paid a US$ 250,000 deposit for US$ 500 million PB guarantee of which entire amount lost.

Decision:

The U.S. District Court for the Southern District of N.Y., Baer, J., granted the SEC's Motion for Summary Judgment and entered final judgment ordering disgorgement and permanent injunctive relief.

Notes:

1. The court stated:

The Commission has established that the prime bank instruments that defendants purported to sell do not in fact exist and are not available on the market. The Commission has submitted affidavits from, inter alia, the Union Bank of Switzerland, Credit Suisse, ABN AMRO Bank, Bank of New York, National Westminster Bancorp., Lloyds Bank Plc., and Bank Ley Ltd, stating that they do not issue standby letters of credit and prime bank guarantees as a means of raising capital and that such instruments are not available on the open market.... While banks do issue letters of credit to their customers, "what does not exist is the business of buying and trading Prime Bank Instruments for profit because there is no market for such instruments to be traded." Securities and Exchange Commission v. Lauer, 864 F. Supp. 784, 792 (N.D. Ill. 1994), aff'd 52 F.3d 667 (7th Cir. 1995).

2. As to the argument that securities laws do not apply to non existent instruments, the court stated:

It is clear by now that the antifraud provisions relied upon by the Commission are applicable even where, as here, the "security" at issue does not exist. See Securities & Exchange Comm'n v. Lauer, 52 F.3d 667, 670 (7th Cir.1995); Mishkin v. Peat, Marwick, Mitchell & Co., 744 F. Supp. 531, 553 n.10 (S.D.N.Y. 1990) ("the fact that the securities did not exist does not remove this action from the operation of the federal securities laws.").

3. The court rejected as irrelevant to the issue of securities fraud the defendants' arguments that the investors were in breach of their agreements in the contracts of sale. Interestingly, many prime bank schemes are designed in such a way that the target will inevitably be in breach, thus giving the scam artist something to hold out as a threat to prevent recourse to the authorities.

4. The gravamen of the case is the violation of the antifraud provisions of the securities acts. "To establish a violation of the antifraud provisions, the Commission must establish that defendants made a misstatement or omission of a material fact in connection with the offer, sale or purchase of a security, and that the defendants acted with the requisite scienter." The court ruled that "[t]he attempt to sell nonexistent securities establishes each of these elements."

5. As to the requirement of scienter, there must be a showing of an intent to deceive, manipulate, or defraud, conscious recklessness, or negligent conduct.

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.