There are some cases that no matter how I digest, abstract, extract, or summarize, I still can't manage to explain things better than the pronouncement from the court or panel. Today's BrokeAndBroker Blog presents one such scenario because both the Southern District of Florida ("SDFL") and the 11th Circuit courts produced cogent rulings that succinctly explained the complexities of disputed custodian account transactions. As such, what follows largely pays homage to the well-crafted decisions from those courts.

Taking The Taurus By The Horns

In the "Background" section of the Order in Douglas Lamm v. State Street Bank And Trust (889 F. Supp. 2d 1321, SDFL, August 21, 2012) https://casetext.com/case/lamm-v-state-st-bank-trust-co#.U1FtYPk7um4, we learn of the following facts (footnotes omitted):

In 2001, Plaintiff hired James Tagliaferri and his investment firm Taurus Advisory Group, LLC ("TAG") as his investment advisers. Plaintiff entrusted a significant portion of his assets to TAG, authorizing TAG to exercise discretion in the purchase, sale, exchange, and disposition of stocks, bonds, and other securities on his behalf. In accordance with the SEC Rules and Regulations which prohibit investment advisers from having direct custody of client funds and securities, Plaintiff established two custody accounts for the holding and disposition of This assets. The first account is governed by a custody account agreement entered into by Plaintiff and Chase Manhattan Bank on January 30, 2001 (the "Chase Agreement"). The second account is an Investment Retirement Account (IRA) and is governed by a separate custody agreement entered into by Plaintiff and Investors Bank & Trust Company on December 6, 2002 (the "IRA Agreement"). In 2007, State Street Bank & Trust Company ("State Street") took over both custody accounts and assumed the obligations of the custody agreements.

From November 2007 to November 2009, TAG, without Plaintiff's consent, engaged in a series of transactions whereby Plaintiff's conservative investments were replaced with purported securities of micro-cap companies and personal loans to friends of Tagliaferri. Upon TAG's instructions, State Street disbursed funds from Plaintiff's accounts in order to effectuate these transactions. In return, State Street received and accepted promissory notes signed by TAG, some of which were made payable to "Hunter & Co.," a company with the same address as TAG. Each of these transactions was reported to Plaintiff in the monthly account statements prepared by State Street pursuant to its obligations under the custody agreements.

On April 28, 2011, State Street sent Plaintiff a letter stating the following:

Beginning with your account statement for September of 2010, we have been including a notice each month highlighting that illiquid, thinly traded and/or private placement securities listed in your account were past due or otherwise past their stated date of maturity and/or that the valuations reported for such assets were provided by your investment manager, TAG Virgin Islands, Inc. (TAG). Despite our repeated attempts to obtain updated valuations or confirmation that we should continue to use the previously reported valuations, we have not received valuation instructions from TAG for these assets since November 30, 2010 and, in the case of warrants valued by TAG, since July 30, 2010. 

As a result of our inability to obtain current valuations from TAG, we will no longer assign a value to the above referenced assets commencing with your April 2010 [sic] account statement. The account statement will indicate a value of zero with respect to these assets. Please note that the valuation of these assets as zero in your statement does not represent an assessment by us of the fair value of these assets but rather serves only to reflect the fact that TAG has not supplied us with current valuations. As previously indicated, we do not provide independent valuations for illiquid, thinly traded and/or private placement securities. We will be including an insert with your account statement describing the above valuation practice in relation to the relevant assets in your account.

The promissory notes deposited by TAG into Plaintiff's accounts were ultimately discovered to be fraudulent, and Plaintiff had "invested" over $1 million in worthless securities and mortgages. Plaintiff now seeks to recover his damages from State Street. According to Plaintiff, State Street "allowed TAG to defraud Plaintiff" by turning a "blind eye" to TAG's activities and accepting notes which were "obviously fraudulent on their face." Plaintiff's seven-count complaint contains claims for breach of express contract, breach of implied contract, breach of fiduciary duty, negligence, gross negligence, aiding and abetting breach of fiduciary duty, and aiding and abetting fraud. Each count contains allegations that State Street breached its duties by (a) accepting the fraudulent promissory notes; (b) failing to notify Plaintiff that certain purported promissory notes were signed by TAG rather than the purported obligor; (c) failing to notify Plaintiff that certain purported promissory notes were executed in favor of Hunter & Co. rather than Plaintiff; (d) disbursing funds to purchase securities without timely receipt of stock certificates in exchange; (e) disbursing funds to other, unknown accounts without receipt of any securities in exchange; (f) reporting false CUSIP numbers on Plaintiff's monthly account statements; (g) reporting inaccurate, inflated, or false market values for the assets held in Plaintiff's accounts; (h) charging excessive custodial fees based on the inaccurate, inflated, or false market values; (i) failing to perform the auditing, reporting, and custodial duties required of IRA custodians; and (j) otherwise failing to notify Plaintiff and the SEC of the "obvious fraud" committed by TAG.

Someone's Gotta Pay For This

In sum and substance, Lamm has been defrauded, but when he went looking at the roster of likely defendants, he apparently realized that the most likely miscreants (TAG and/or Tagliaferri) probably didn't have anything amounting to deep pockets, assuming they even had any pockets left. Faced with those likely penurious defendants, Lamm's gaze likely fell upon the flush State Street. Hey, under the circumstances, who can blame the guy for taking a shot?

In good faith and/or desperation, Lamm pursued his allegations that State Street essentially knew or should have known that his pockets were getting picked and that the company failed to protect him from such deprivations.  As far as litigation theories go, that one is fairly generic for these types of disputes; however, smack dab in Lamm's path is whether a custodian in State Street's shoes had the duties and obligations to look over the shoulders of TAG and Taliaferri and convey any concerns to him. 

Motion To Dismiss

Under the circumstances, Lamm put together an impressive Complaint, but State Street had a few pre-trial cards up its sleeve, and played them well and with devastating results. State Street moved to dismiss Plaintiff Lamm's Complaint based upon its contention that its role as account custodian was strictly ministerial in nature and, accordingly, it had no duty to guard against the investment advisor's alleged misconduct attached. 

The SDFL granted State Street's motion to dismiss contract claims and ruled that Lamm's negligence claims were barred by Florida's Economic Loss Rule (at the time of the SDFL decision, the Rule generally barred tort claims between contractual parties but has now been largely limited to products liability claims). Finally, SDFL concluded that Lamm had failed to sufficiently demonstrate knowledge on the part of State Street, and as a result his aiding and abetting claims had to be dismissed.

Sustained

On appeal the 11^th Circuit sustained the District Court's rulings.

Finding Taurus was listed in the custody agreement as an authorized agent of Lamm, the Circuit inferred from that circumstance that State Street:

• was entitled to rely on Taurus' instructions to buy or sell securities or transfer funds to third parties;
• had no investment-decision-making role; and
• was relegated to holding Lamm's assets, carrying out his and Taurus' investment instructions, and rendering accounts. 

• assumed no responsibility for supervising investments or making investment recommendations; 
• assumed no liability for losses arising out of account transactions except as caused by State Street's negligence or willful misconduct; and 
• had no duties beyond those expressly set forth in the custodian agreement.

The Circuit found contractual authority entitling State Street to rely on Taurus' instructions; and although the court did concede that State Street could not shield itself from its own negligence in carrying out its contractual duties, no proof of such shortcomings was found. Moreover, Lamm failed to persuade the court that State Street owed him an independent duty to monitor the investments in his account, verify their market value, or ensure they were in valid form. 

In affirming SDFL's dismissal, the Circuit noted:

As events of the past and present unfortunately remind us, investors are sometimes easy targets for unscrupulous financial advisors.¹⁰ We empathize with Mr. Lamm, who was defrauded by Mr. Tagliaferri and Taurus, but on the facts alleged Mr. Lamm cannot hold State Street liable for his losses.

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10 See, e.g., JORDAN BELFORT, THE WOLF OF WALL STREET (2007); MITCHELL ZUCKOFF, PONZI'S SCHEME: THE TRUE STORY OF A FINANCIAL LEGEND (2006).

READ the FULL-TEXT Decisions:

• Douglas Lamm v. State Street Bank And Trust (11^th Circuit, 12-15061, 12-CV-80317, April 14, 2014)
• Lamm v. State Street (889 F. Supp. 2D 1321, SDFL, August 21, 2012)