Lesson of a Ponzi Scheme: Know Your Customer

Scott Rothstein needed a big financial institution to keep his scam going. TD Bank should have managed its risks better.

The senior management of Canada’s big Toronto-Dominion Bank learned a valuable lesson recently about the risk of having the wrong customer.

CaseStudy_BugAn American subsidiary of the bank, TD Bank, agreed to pay $52.5 million to settle accusations that it had helped a Florida lawyer, Scott W. Rothstein, commit a Ponzi scheme estimated at $1.2 billion.

Rothstein’s scam involved persuading investors to put money into “structured settlements.” Investors were told that these were settlements of cases that involved sexual harassment, workplace discrimination and other complaints against certain companies.

He explained to investors that these companies had agreed to pay money over time to his clients in return for their silence. Those clients would sell the right to the payments in return for an upfront payment from the investor. He assured each investor that all the money was paid into escrow accounts he administered.

To pull off such a scheme, Rothstein needed a financial institution to set up bank accounts so he could move money around.  At the time the Ponzi scheme began, Rothstein was using a small bank, Gibraltar Private Bank and Trust.

He later testified to investigators that he had “protection” from officers at that bank, but as the Ponzi scheme expanded, Gibraltar employees started asking more due-diligence questions about Rothstein’s account. He realized that to attract larger investors, including hedge funds, he needed to use a larger bank to assure investors that there was protection from a possible bank failure while the bank held their money.

Rothstein’s solution was to move his account to Commerce Bank, which was later acquired by Toronto-Dominion. But he needed an ally at the bank to keep his Ponzi scheme alive.  Dangling a carrot in front of TD Bank regional vice president Frank Spinoza, the lawyer bragged to him that he could introduce him to some large clients.

Spinoza was so star-struck by Rothstein’s influence and wealth that he made material misstatements and omissions to investors and prepared false and misleading documents that he knew Rothstein would provide to investors.

As the Ponzi scheme began to unravel, Spinoza lied to investors concerning the safety of the investment. For example, he allegedly told them that the funds were locked into their bank accounts and could not be transferred when they could.

He also told at least two investors that the trust accounts held balances totaling “hundreds of millions of dollars,” when, in reality, the SEC claimed that “the settlements Rothstein sold to investors did not exist and the purportedly ‘locked’ accounts generally held no more than $100.”

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