As I have commented upon, victims of fraud and particularly Ponzi schemes often find themselves without a fund from which to recover their alleged damages because the fraudsters have squandered the money or are otherwise judgment-proof. In such circumstances, claims of “aiding and abetting” fraud and breach of fiduciary duty play an important role.
There is indeed a separate free-standing cause of action known as “aiding and abetting” fraud that can be asserted against those who may have been involved in or participated in the fraud with the principal fraudster(s) who turns out to be without the means to pay the damages. The oft-cited elements of such a cause of action are fairly basic and straightforward: “In order to plead properly a claim for aiding and abetting fraud, the complaint must allege: ‘(1) the existence of an underlying fraud; (2) knowledge of this fraud on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in achievement of the fraud’.” Stanfield Offshore Leveraged Assets, Ltd. v Metro. Life Ins. Co., 64 AD3d 472, 476 (1st Dep’t 2009)(citation omitted).
Aiding and Abetting and Proximate Cause
Within the third element of “substantial assistance,” however, courts also examine whether the acts that allegedly constitute the “assistance” were a “proximate cause” of the alleged damages. This element has been elaborated upon in many federal court decisions in New York. See, e.g., JP Morgan Chase Bank v Winnick, 406 F Supp. 2d 247, 256 (SDNY 2005)(“Whether the assistance is substantial or not is measured, in turn, by whether ‘the action of the aider and abettor proximately caused the harm on which the primary liability is predicated.’ In re WorldCom, Inc., at 560–61 (citations omitted). Essentially, ‘[t]he substantial assistance element has been construed as a causation concept, requiring that the plaintiff allege that the acts of the aider and abettor proximately caused the harm upon which the primary liability is predicated.’ Primavera Familienstiftung v. Askin, 173 F.R.D. 115, 126 (S.D.N.Y.1997).”); Pension Comm. of Univ. of Montreal Pension Plan v Banc of Am. Sec., LLC, 446 F Supp. 2d 163, 201-02 (SDNY 2006)(“the plaintiff must allege that the aiding and abetting defendant proximately caused the harm on which the primary liability is predicated. ‘But-for’ causation is insufficient; aider and abettor liability requires the injury to be a direct or reasonably foreseeable result of the conduct. At least with respect to an aiding and abetting fraud claim, the ‘substantial assistance’ and ‘causation’ elements are interrelated—‘[w]hether the assistance is substantial or not is measured … by whether the action of the aider and abettor proximately caused the harm on which the primary liability is predicated.’”); McDaniel v Bear Stearns & Co., Inc., 196 F Supp. 2d 343, 359 (SDNY 2002)(“Proximate cause exists where defendant’s actions were ‘a substantial factor in the sequence of responsible causation,’ and plaintiff’s injury was ‘reasonably foreseeable or anticipated as a natural consequence.’ First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 769 (2d Cir.1994). Claimants’ injury must either have been ‘the natural and probable consequence of the fraud’ or an injury that [defendant] ‘ought reasonably to have foreseen as a probable consequence of the fraud;’ [Defendant] need not have foreseen or intended the damages suffered by Claimants. The City of New York v. Coastal Oil of New York, No. 96 Civ. 8667, 1999 WL 493355, at *12 (S.D.N.Y. July 12, 1999) (citing Citibank, N.A. v. K–H Corp., 968 F.2d 1489, 1496 (2d Cir.1992); Cumberland Oil Corp. v. Thropp, 791 F.2d 1037, 1044 (2d Cir.1986); Nat’l Commercial Bank v. Morgan Stanley Asset Mgmt. Inc., No. 94 Civ. 3167, 1997 WL 634292, at *7 (S.D.N.Y. Oct.15, 1997)).”).
In the New York State courts, the federal principles have been relied upon as well. See Stanfield Offshore Leveraged Assets, Ltd. v Metro. Life Ins. Co., 64 AD3d 472, 476 (1st Dep’t 2009)(“Substantial assistance exists ‘where (1) a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed, and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated’ (UniCredito Italiano, 288 F.Supp.2d at 502 [internal quotation marks omitted], quoting McDaniel v. Bear Stearns & Co., Inc., 196 F.Supp.2d 343, 352 [S.D.N.Y.2002] ).”).
A new decision of the United States District Court for the Southern District of New York (Rakoff, J.) granted the defendants summary judgment by relying entirely on what it ruled was plaintiffs’ failure to establish that the alleged assistance of the “aiders/abettors” proximately caused the alleged damages — Senior Health Ins. Co. of Penn. v. Lincoln Int’l LLC, Case Number: 19-cv-7137 (S.D.N.Y. April 10, 2020).
Senior Health involved a large fraud/Ponzi scheme reported in the media as the Platinum-Beechwood fraud. See generally In re Platinum-Beechwood Litig., 427 F Supp. 3d 395 (SDNY 2019) for the background.
In the Senior Health case, “plaintiff Senior Health Insurance Company of Pennsylvania (‘SHIP’) filed an amended complaint against defendants Lincoln International LLC (‘Lincoln International’) and Lincoln Partners Advisors LLC (‘Lincoln Partners’), alleging that Lincoln International and Lincoln Partners (collectively, ‘Lincoln’) participated in the Platinum-Beechwood fraud in their joint capacity as a valuation services provider.” In essence, SHIP alleged that defendant Lincoln provided independent valuations issued to the Board of Directors of Beechwood to opine whether the investments made by Beechwood were reasonable in accordance with “Financial Accounting Standards Board Codification, Topic 820 — Fair Value Measurements and Disclosures.” SHIP had contractual agreements with Beechwood under which Beechwood was engaged to invest SHIP’s funds and receive fees based upon the return received on those investments. An entity known as Platinum was the subject of many of Beechwood’s investments. “Subsequently, a series of government investigations, criminal actions, and civil actions commenced against Platinum and Beechwood entities and individuals (as well as others), alleging that they, inter alia, engaged in fraudulent overvaluations of net asset values of Platinum and Beechwood investments and concealed from investors the close ties between Platinum and Beechwood. See, e.g., In re Platinum-Beechwood Litig., Nos. 18- cv-6658, 18-cv-10936, 18-cv-12018 (JSR) (S.D.N.Y.); United States v. Nordlicht et al., No. 16-cr-00640 (BMC) (E.D.N.Y.); SEC v. Platinum Management (NY) LLC et al., No. 16-cv-06848 (BMC) (E.D.N.Y.).”
Among other litigations, in this case, SHIP alleged that Lincoln aided and abetted Beechwood’s fraud, resulting in damages to SHIP. In the subject decision, Judge Rakoff considered Lincoln’s motion for summary judgment to dismiss the claims of aiding and abetting fraud and breach of fiduciary duty. Judge Rakoff granted the motion and dismissed these claims entirely.
To start, Judge Rakoff set out the elements of the claims as follows:
“To establish liability for aiding and abetting fraud under New York law, the plaintiffs must show (1) the existence of a fraud; (2) the defendant’s knowledge of the fraud; and (3) that the defendant provided substantial assistance to advance the fraud’s commission.” Krys v. Pigott, 749 F.3d 117, 127 (2d Cir. 2014).
“A claim for aiding and abetting a breach of fiduciary duty requires, inter alia, that the defendant knowingly induced or participated in the breach.” Krys v. Butt, 486 F. App’x 153, 157 (2d Cir. 2012) (summary order). Furthermore, “[a] person knowingly participates in a breach of fiduciary duty only when he or she provides substantial assistance to the primary violator.” Baron v. Galasso, 921 N.Y.S.2d 100, 104 (2d Dep’t 2011).
Because “the same activity is alleged to constitute the primary violation underlying both claims,” the claim for aiding and abetting fraud here overlaps substantially with the claim for aiding and abetting breach of fiduciary duty. Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt., LLC, 479 F. Supp. 2d 349, 360 (S.D.N.Y. 2007). For this reason, except where otherwise stated, these two claims are analyzed together.
The substantial assistance element is established “when a defendant affirmatively assists, helps conceal or fails to act when required to do so, thereby enabling the breach to occur.” Lerner v. Fleet Bank, N.A., 459 F.3d 273, 295 (2d Cir. 2006).
Judge Rakoff then noted without much elaboration that “embedded in the substantial assistance element is the concept of proximate causation, which requires a showing that ‘a defendant’s participation [was] the proximate cause of plaintiff’s injury.’ Dubai Islamic Bank v. Citibank, N.A., 256 F. Supp. 2d 158, 167 (S.D.N.Y. 2003).”
Judge Rakoff then used the requirement of proximate cause alone as the basis for granting summary judgment. The Court ruled that “there is no evidence that Lincoln’s valuation marks allowed Beechwood to withdraw unearned performance fees [from SHIP].” It continued: “Out of tens of millions in performance fees that Beechwood withdrew from SHIP’s accounts over many years, only one performance fee of $1,000,000, based on the valuations as of September 30, 2014, was withdrawn during Lincoln’s engagement with Beechwood. … That withdrawal occurred at least three months before Lincoln first issued its valuation report and before Lincoln’s marks were allegedly delivered to SHIP through the January 31, 2015 Wilmington statement. … Therefore, there cannot be proximate causation between Lincoln’s valuations and the withdrawal on October 2, 2014.”
As to SHIP’s alternative argument that Lincoln enabled Beechwood to maintain unjustified fees at a subsequent “true-up,” the Court again rejected the argument: “… SHIP fails to explain how … any valuation work that Lincoln did up to February 19, 2015, had any bearing on Beechwood’s annual true-up obligation in 2015 that was measured as of December 31, 2015. In sum, even assuming arguendo that Lincoln overvalued SHIP’s investments with Beechwood, such conduct did not proximately cause SHIP’s injuries. Therefore, Lincoln did not, by means of alleged overvaluation, substantial[ly] assist Beechwood’s primary fraud and breach of fiduciary duty.”
The Court went on to reject any duty on the part of Lincoln to affirmatively reveal or disclose information since “it is axiomatic that mere inaction cannot constitute substantial assistance unless ‘the defendant owes a fiduciary duty directly to the plaintiff,’ which Lincoln did not.”
Aiding and abetting fraud is a viable cause of action that can extend the remedies available to victims of fraud to others beyond the primary fraudsters. Of course, the foundation of any such claims is establishing all of the elements of the underlying fraud to begin with. If such a fraud exists, then the additional elements of the aiding and abetting claim come into play. As with the main fraud cause of action, a plaintiff must establish that the acts (or omissions if there is a duty to disclose) proximately caused the damage alleged. This requires both a substantial factor in causing the damage as well as that some sort of damages were foreseeable.