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NY: NJ Law Firm Gets Snagged as "Aiding and Abetting" a Ponzi Scheme

 Oster v. Kirschner, et al 2010 NY Slip Op. 05981 (App Div, 1st Dept. 7-6-2010)

NY: Underlying Private  investment

FACTS: A NJ law firm, Lum, Danzis, Drasco & Positan,LLC lost its bid to stay out of a NY law suit brought by investors in a private investment  plan named Cobalt,  which turned out to be a Ponzi scheme  operated by a convicted felon with the help of an admitted criminal with numerous convictions for securities violations and  who was banned from the securities industry.  Investors lost over $22 million. As Cobalt’s attorneys,  the law firm is accused of preparing the private placement memorandum  (PPM) which failed to disclose the criminal histories  of the investment’s managers, although the Firm’s attorneys were aware of it.  Also, the PPM allegedly contained other affirmative misrepresentations to which plaintiffs pointed in their "aiding and abetting" , fraud and breach of fiduciary duty Complaint. The Law Firm also served as the  escrow agent for the investment transactions. The Law Firm "did not seriously dispute that they had knowledge of [their clients’] criminal backgrounds." It just claimed that knowledge and the knowledge of misrepresentations in the PPMs–"the admitted vehicle by which investment in the Ponzi scheme was carried out–does not sufficiently allege actual knowledge…"

ISSUE: Does the Complaint adequately plead fraud, or should the trial court’s dismissal of the Complaint be reversed?

HELD: Order dismissing Complaint reversed. Complaint re-instsated.

1. A plaintiff alleging an aiding and abetting fraud claim must allege the existence of he underlying fraud, actual knowledge and substantial assistance.  Actual knowledge of fraud can be "discerned from surrounding circumstances."

2. The Law Firm’s preparation of the PPM, including, significantly, a backdated amendment to it that showed the investment managers criminal past which it had not previously disclosed, constitutes "substantial assistance."

The PPMs authored by defendant attorneys were the means by which the Cobalt…entities were able to solicit funds for …[the] Ponzi scheme. The PPM is the very mechanism by which investments such as Cobalt are placed in the marketplace, and the admitted "but for" cause of plaintiff’s investment losses. Yet defendants assert that "loss causation" is lacking because it has not been adequately pleaded that defendant attorneys had actual knowledge that their clients–whom they admittedly knew to be criminals, banned from the securities industry for engaging in fraudulent investment schemes–would operate…Cobalt…as a Ponzi scheme. If the facts and circumstances herein do not support an inference of actual knowledge, then it is doubtful that any action for aiding-and-abetting fraud could be sustained against any attorney, who, like defendant attorneys, consciously chose to look the other way when their clients asked them to prepare the PPM…To say that defendant attorneys merely furnished legal services to help solicit investments in…Cobalt…, and did not have knowledge of the fraud they helped perpetrate…[is] simply not tenable. The Court cannot and will not endorse what is essentially a "see no evil, hear no evil" approach. 

LESSON:  Is the NY Court expanding the duty of vigilance of the lawyer regarding disclosure of information that non-clients should be entitled to know?  Will there be an appeal from this ruling? Let’s wait and see. 

For an interesting NJ case involving a different NJ law firm also involved in composing a "defective" PPM, see Profit Sharing Trust v. Lampf Lipkind, 630 A.2d 1191 (1993).

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Posted in: Commercial, Fiduciary Duty, New York