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

Defendant/Alleged Scamsters- Jeffrey S. Norton; Donald S. Reynolds; John A. Tartaglia; Edward T. Menster

False Instruments:

Prime bank instruments, prime bank notes, bank debentures, bank guarantees, letters of credit issued by the "top banks in the world."

Activities:

1) In August 1993, deposit of US$ 1 million for 45 days for return of $150,000 to facilitate prime bank trading program. Associate attorney of New York law firm individually acted as escrow holder. .

2) Trading in prime bank notes with investment of US$ 1.5 million which would return from $200,000 to $300,000 per week. Victim invested $125,000.

Decision:

The U.S. District Court for the Southern District of New York, Stein, J., granted in part and denied in part. Defendant Tartaglia's Motion to Dismiss for failure to state a cause of action and for lack of subject matter jurisdiction. Under the ruling, the action against Tartaglia for violation of the anti fraud securities law remains insofar as the complaint alleges that he participated in the fraudulent scheme with regard to the alleged pledge of stock

Notes:

1. One phase of this scam used an escrow arrangement. The funds were held by an attorney but control was in the hands of one of the scamsters who had the power to "instruct the escrow holder to exchange the escrowed funds for case equivalents such as stocks, bonds or other marketable instruments." The scamster sent the escrow holder a certificate for 1,000 shares of stock in Sabre Credit Corp., a corporation of which one of the scamsters was the sole officer. In addition, a forged letter purportedly from a major accounting firm valued the shares at more than US$ 7 million.

2. Since the SEC's claim did not appear to be "frivolous or made solely for the purposes of obtaining jurisdiction," the court found that jurisdiction existed.

3. The operative language of the stature is that a "manipulative or deceptive device or contrivance" must be used in a "transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser" in which there were "material misstatements or omissions indicating an intent to deceive or defraud in connection with the purchase or sale of a security." The relevant statutes are Sections 17(a), 17 (b), and 17 (c) of the Securities Act, 15 USCA Section 77(q)(a)- (c), and Section 10(b) of the Securities Exchange Act, 15 USCA Section 78(j)(b).

4. Tartaglia contended that the court lacked subject matter jurisdiction because there is no security at issue and the alleged fraud was not committed in connection with any sale, offer, or purchase of securities as required by the anti fraud statutes. The court did not reach the question of whether or not prime bank instruments are securities (the opinion stated that "it appears that they are") because the alleged fraudulent inducement in obtaining the escrow fund was not made "in connection with the purchase or sale" of an alleged fictitious security as required by the statutes. The funds were never intended to be used to purchase PB instruments but to be shown to the seller as "earnest money." The court concluded that:

Rather than alleging in the complaint that Norton was going to use the money in the escrow account to purchase PBI's, the SEC instead alleges that funds would be used to "facilitate" the purchase by "showing the seller of the instruments that $ 1 million was held in an escrow account." (Complaint, P 12). It also alleges that defendants misrepresented to Thurman that Norton was able to purchase PBI's without knowing whether such instruments existed. (Com-plaint, P 11). This misrepresentation, however, was not made in connection with the purchase, offer, or sale of the PBI's. This differs from those cases in which individuals are fraudulently misled to attempt to purchase PBI's based upon representations of expected profit. Here, Thurman was not fraudulently induced to purchase PBI's or any other security. Rather, according to the complaint, he was misled into transferring funds into an escrow account with the representation that his funds, plus a fee, would be returned within 45 days. This situation is no different than if Thurman had been induced into the escrow transaction based on false allegations of a profitable real estate transaction that Norton was about to enter. In this sense, the alleged fraud, as Tartaglia contends, is a garden variety fraud, not one made in connection with the purchase or sale of a security.

5. The opinion notes that the securities laws:

are not designed to address frauds that are ancillary to a securities transaction, as is the case here. A similar scenario involving a fraud that is ancillary to the sale or purchase of securities can be found in Bischoff v. G.K. Scott & Co., Inc., 687 F. Supp. 746 (E.D.N.Y. 1986). In that case, the plaintiff alleged that the defendant broker, in order to induce the plaintiff to open a non-discretionary account with the defendant, promised to limit speculative transactions to $ 10,000. See id. at 748. When the plaintiff started investing the money in his account, the defendant immediately breached this promise and the plaintiff lost money. The court dismissed the action, holding that:

in general, misrepresentations made by brokers inducing the opening of an account are not actionable under the federal securities laws. Because such broker misrepresentations are connected to the broker's efforts to attract the investor's business, and are not tied to a particular trade, they do not meet the Rule 10b-5 requirement that an actionable misrepresentation be in connection with the purchase or sale of securities. . . . Such is the case here. While [the broker's] statement that he would limit trades in accordance with plaintiff's instructions may have induced plaintiff to open the account, the statement was not connected to an actual purchase or sale of securities.Id. at 749 (emphasis added).

6. The court concluded, however, that the pledge of 1,000 shares of stock from Sabre Credit Corp. as collateral for the funds in the escrow account constituted an "offer" or "sale" under securities laws. The court noted that the investor:

was not a security holder until his cash in the escrow account was replaced with a pledge of securities. The change is significant since Thurman went from not having a security investment to having one. Tartaglia also contends that there was no new investment because the escrow agreement states that the escrow funds could be replaced at any time by an equivalent amount in stocks, bonds, or other instruments. The complaint alleges, however, that defendants repre-sented to Thurman that, notwithstanding the language of the escrow agreement, his funds would remain safely in the escrow account and would not be removed or transferred under any circumstances. (Complaint, P 12, 17).

7. In another phase, the scamsters accused the investor that he was responsible for the failure of the investment fund to reach its goal, that this failure jeopardized the prime bank note purchase, and that it would result in forfeiture of the funds deposited. An attempt to place "blame" on the victim is a common feature of these scams.

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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.