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Banking and Finance

Bank Hit With $72 Million Judgment for Role in $100 Million Ponzi Scheme

 An Ohio-based bank was tagged with a $72 million judgment - ballooning to nearly $83 million with accrued interest - for its role in providing banking services to a notorious Ponzi schemer who committed suicide as authorities closed in. Huntington Bank, a publicly-traded company with hundreds of branches concentrated on the east coast, was found liable for the return of over $72 million in fraudulent transfers it received from companies operated by Barton Watson during 2003 and 2004. The judgment, which the bank has announced it will appeal, would represent one of the largest awards issued against a financial institution for its role in a Ponzi scheme, and would also likely represent a sizeable recovery for victims of Watson's massive Ponzi scheme.

The Scheme

Barton Watson operated CyberNet Engineering, which touted itself as a highly-successful provider of information technology services. CyberNet purported to achieve annual revenues ranging from $200 million to $300 million primarily through the sale of computer hardware to top-tier clients. However, Watson and CyberNet were increasingly on the radar of authorities, and the FBI raided company headquarters in November 2004. While no charges were initially filed, Watson committed suicide later that same month following a standoff with police in his barricaded home.

An ensuing investigation revealed Watson's intricate use of subsidiaries and shell companies to manufacture the dizzying business growth touted to investors. One of these companies was Cyberco Holdings, Inc. ("Cyberco"), which secured loans from lenders for the purported purchase of computer hardware. Cyberco told its lenders that it would be purchasing this hardware from Teleservices Group, Inc. ("Teleservices"), and Teleservices received the loan proceeds after providing invoices to lenders. However,Teleservices was another entity controlled by Watson, and neither Teleservices not Cyberco ever engaged in any legitimate hardware deals. Instead, the loan proceeds obtained by Teleservices were simply funneled back to Watson.

Huntington Bank

Huntington Bank provided banking services to Watson and his entities, with these services including the use of a $17 million revolving credit line that would advance new credit as payments were received on the loan. The credit line was used frequently by Watson and his entities. However, Huntington began raising suspicious about the relationship sometime in 2003 after it observed suspicious payments coming fromTeleservices to pay down the Cyberco line of credit, and soon thereafter asked Watson to find a new lender. The bank initially suspected Watson of check kiting, but allowed the continued payments byTeleservices towards the revolving credit line. In total, more than $73 million in payments were made byTeleservices towards the Cyberco line of credit.

After Teleservices filed bankruptcy following the FBI raid, the trustee subsequently filed fraudulent transfer claims against Huntington not just for the payments received by Teleservices but instead for the entire amount of funds that flowed through the account and were reloaned to Cyberco. Following a three-week trial, the court rejected Huntington's good-faith defense, noting numerous examples of the bank turning a blind eye to obvious red flags, and concluded the bank was on the hook for the $72 million that flowed through its Cyberco account.

Of note in the bankruptcy court's decision, which was later confirmed and accepted by the district court, was the analysis of the "good faith" defense provided to transferees of allegedly voidable transfers under certain provisions of the U.S. Bankruptcy Code. For example, Sections 548 and 550 of the bankruptcy code provide an affirmative defense to recipients of fraudulent transfers if they demonstrate that they received the transfer in good faith and provided value. Courts analyzing good faith have wrestled with whether to analyze a transferee's good faith in an objective or subjective standard. However, in Judge Jeffrey Hughes' Report and Recommendation in the Teleservices litigation, he rejected the use of an objective standard and instead held that Huntington's good faith would be evaluated subjectively. Ultimately, Judge Hughes found that Huntington could not establish good faith as to any transfers received after April 30, 2004. In the district court's order adopting Judge Hughes' R&R, Judge Paul L. Maloney observed:

The objective standard has not been explicitly adopted by the Sixth Circuit, and the Sixth Circuit has, at least implicitly, endorsed a good faith standard that allows for subjective considerations. The Court finds Judge Hughes accurately assessed the relevant standards for determining a good faith defense. His dissection of the prevailing trend toward an objective standard of good faith reads like an academic treatise. The Trustee’s objection does not demonstrate any dispositive flaw in Judge Hughes’ reasoning. Furthermore, the phrase “good faith” is used multiple times in § 548 through § 550. In § 548© and § 550(e)(1), the phrase “good faith” is used without any additional reference to the knowledge of the transferee orobligee. In § 549© and § 550(b)(1), the phrase “good faith” is used with an additional reference to some knowledge.

Interestingly, Judge Hughes also concluded (and Judge Maloney agreed) that Huntington Bank was an immediate transferee simply upon a customer's deposit of funds into an account held at the bank, reasoning that the bank exercised sufficient control over those funds to be considered a subsequent transferee under the relevant portions of the Bankruptcy Code. While the District Court noted disagreement among other courts, it cited Judge Hughes' painstaking analysis and ultimate rejection of those cases.

The implications of Judge Hughes' decision are widespread. First, it endorses the tactic taken by the trustee in seeking to recover the entirety of funds flowing through Huntington rather than simply profits enjoyed by Huntington or the amount specifically received from Teleservices. This becomes even more striking when observing that Huntington was found liable for over $70 million despite extending "only" a $17 million credit line. However, while banks have typically enjoyed wide latitude in disclaiming responsibility for policing their customers, Judge Hughes' decision stands for the proposition that a bank cannot willfully blind itself to an active fraud being perpetrated by a customer. Second, the decision is likely to breathe new life (and inflate potential damages) in similar suits going forward while simultaneously giving bank counsel a new reason to fear fighting the case in court. While Judge Hughes' decision is not binding across the country, it certainly provides a contrary perspective to the familiar defenses advanced by banks.


Last week, Huntington Bank appealed the judgment and requested that it not be required to post an adequate bond to stay execution of the judgment. In defense of its request to avoid having to put up an $80 million bond, Huntington's attorneys argued that:

The bond is not warranted in any event because Huntington indisputably has the resources to pay the judgment against it should the Trustee ultimately prevail...

However, counsel for the trustee took issue with this position, responding that:

"Rather than avail itself of that option, Huntington asks this Court and Plaintiff to rely on Huntington's self-serving, unattested assurances of present and future financial stability...How reliable are Huntington's paper promises? It is difficult for anyone to know. But, there is a disinterested competitive market solution: let the sureties with their actuarial expertise in assessing collection risk make the determination. Plaintiff has carried the risk of Huntington'sfailure for years. Judgment has now been entered."

Judge Maloney's recent Order adopting Judge Hughes' R&R

 For more news and analysis of Ponzi schemes, visit Ponzitracker, a blog by Jordan Maglich, an attorney at Wiand Guerra King P.L.

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