Corporate Governance

Marion v. TDI and Financing a Fraud: The Need for Proximate Cause

By Brian Rulla

In Marion v. TDI, Inc., 2010 WL 6189 (3d Cir. Jan. 4, 2010), the United States Court of Appeals  for the Third Circuit held that the receiver from a defunct broker involved in a Ponzi scheme had standing to bring suit against third parties who allegedly assisted the scheme.  In order to prevail on a claim to recover damages from the third party affiliates, however, the receiver needed to establish that the actions of the third parties were the proximate cause of losses, not simply enabling the losses to continue.

Robert Bentley formed Bentley Financial Service, Inc. (BFS) to broker bank issued certificates of deposit (CD's) with depositors.  Brokers generally offered the CD's at rates lower than what the banks paid, thereby earning the difference, or 'spread.' 

Brokers also sold CD's with differing maturities than those offered by the bank.  Brokers were obligated to inform investors of this 'mismatching' of maturities.  Moreover, when an investor purchased a CD with a shorter maturity, the broker was required to produce the funds needed to liquidate the investor's position at the expiration of the shorter maturity.  The broker could either find a new investor for a short term CD, temporarily sell the long term CD to a bank with an agreement to repurchase, or require the investor to stay invested for the duration. 

When Bentley began having cash flow problems to meet the demands of his customers he started selling fictitious CD's to investors.  Bentley would use the proceeds from the sale of fictitious CD's to pay out prior investors in a typical Ponzi scheme structure.  Bentley also employed the services of two other individuals, Ted Benghiat, owner of SFG Financial, Inc, (Benghiat) and Joseph Marzouca, Vice President of Peninsula Bank (Marzouca).  On at least three occasions, both men provided Bentley with cash that helped keep "Bentley's operation afloat."

After the SEC filed a civil action against Bentley, the court appointed David H. Marion as receiver for BFS. Marion then brought an action against Benghiat and Marzouca alleging that they aided and abetted or conspired in Bentley's fraud.  The jury found both Benghiat and Marzouca liable and awarded combined damages of almost $33 million.  Benghiat and Marzouca moved for judgment as a matter of law, arguing that Marion, as the receiver for BFS, lacked standing because it was the investors, not BFS that suffered injury from Bentley's fraud. 

Marion argued, conversely, that Benghiat's and Marzouca's actions allowed Bentley to perpetuate his fraud further, causing the BFS to incur even greater losses than would have been otherwise possible.  The court accepted the argument ("This claim, if plausible (and for purposes of this opinion we assume it is), steps over the relatively low standing threshold.") and concluded that the receiver had standing against those third parties who helped the management of that corporation perpetuate the fraud.  

Despite the fact that Marion, as receiver, had standing to bring a claim against Benghiat and Marzouca, the court ultimately ruled that there was no liability.  The defendants could not be liable to the extent they engaged in practices that increased the company's short-term liquidity, even when doing so allowed the company to "stay afloat long enough to put itself in a worse position than it was in prior to the cash infusion." 

While the aid and financing that Benghiat and Marzouca provided to Bentley may have caused BFS to suffer additional harm by increasing its losses, those actions did not rise to the level of proximate causation.  Bentley's intervening act, how he used the financing, stood between the act of injecting cash into the business and the ultimate harm suffered by investors. 

The primary materials in this case can be found at the DU Corporate Governance Web Site.

Full post as published by The Race to the Bottom on February 27, 2010 (boomark / email).