Banking and Finance Law Daily Bank immune under Bank Secrecy Act for report filed in bad faith
Thursday, April 18, 2019

Bank immune under Bank Secrecy Act for report filed in bad faith

By Nicole D. Prysby, J.D.

A financial institution is immune from liability under the BSA for a SAR, even if the SAR was filed in bad faith or was filed for a malicious intent. There is no "good faith" requirement to claim immunity under the BSA—Congress could have added such a requirement, but did not.

A financial institution is immune from liability under the Bank Secrecy Act (BSA) for a suspicious activity report (SAR) even if the SAR was filed in bad faith because the bank was attempting to cover up its own wrongdoing, held the federal First Circuit Court of Appeals. After Fidelity Brokerage Services lent shares from a client’s account without permission, Fidelity filed a SAR, accusing the clients of manipulating the stock price of the company. First Circuit law bars the claims because that court has held that the BSA immunizes financial institutions even if their disclosures are unfounded or even malicious, as long as they identify a possible violation of law. Congress easily could have added a good-faith requirement to the BSA but did not (AER Advisors, Inc. v. Fidelity Brokerage Services, LLC, April 17, 2019, Thompson, O.).

Background. William and Peter Deutsch (father and son) were clients of investment advisor AER Advisors, Inc. (AER) and officers of a billion-dollar company called Deutsch Family Wine & Spirits. In 2009, AER joined Fidelity’s Wealth Central platform, giving it access to Fidelity's investment technologies. In 2011 and 2012, the Deutsches pursued an investment strategy introduced by AER and supported by Fidelity—a strategy that resulted in their acquiring millions of shares of China Medical Technologies, Inc. (China Medical), all in the hopes of making a profit from an eventual management buy-out or a third-party acquisition. In March 2012, Fidelity offered the Deutsches the chance to participate in its "fully paid lending program," in which they would lend Fidelity their China Medical shares for an interest-based fee. The Deutsches declined, but Fidelity lent about 1.8 million of the Deutsches’ China Medical shares to short sellers or their brokers between May and early June 2012.

Fidelity made money from these loans. But the Deutsches received no notice of what Fidelity was up to, no collateral to protect their interests, and no compensation. Fidelity’s surreptitious lending triggered a recall obligation, and China Medical’s stock price went from $4.00 per share on June 13 to $11.80 per share on June 29. Fidelity ended up buying roughly 1.2 million shares on the open market between June 19 and June 27. Sometime around July 5, 2012, Fidelity filed a SAR, accusing the Deutsches of manipulating China Medical’s stock price. In August 2012, the Securities and Exchange Commission (SEC) kicked off an investigation of both AER and Peter Deutsch for possible market manipulation of China Medical. Ultimately, neither the SEC nor the state agencies pursued enforcement actions against AER or Peter Deutsch.

Invoking diversity jurisdiction, the Deutsches and AER later sued Fidelity in Florida’s federal district court. Their complaint contained an array of Florida-law claims, including claims predicated on the SAR. Fidelity moved to dismiss the complaint or to transfer the case to Massachusetts’s federal district court. The Florida court transferred the case to Massachusetts. Fidelity motioned to dismiss, arguing that First Circuit law applied to federal questions transferred to the court and that the BSA provides a financial institution with absolute immunity from civil liability for filing a SAR. The district court sided with Fidelity, holding that First Circuit law applies and that BSA grants financial institutions absolute immunity from suit, even for disclosures that are fabricated or made with malice.

The plaintiffs appealed, arguing that Eleventh Circuit precedent (which requires a good faith suspicion to claim BSA immunity) applies because the case came to the First Circuit via a transfer order from a court in the Eleventh Circuit, and that even if First Circuit precedent applies, the court should not read the BSA as immunizing an institution that filed a report that falsely implicated the victim of the financial institution’s own wrongdoing.

First Circuit law governs the case. This was a question of first impression for the court, but every circuit considering it so far has concluded that when one district court transfers a case to another, the norm is that the transferee court applies its own circuit’s cases on the meaning of federal law. If a federal court transfers a diversity case under § 1404(a), the transferee court applies the state law that the transferor court would have applied to any questions of state law but nothing compels one federal court to apply another’s interpretation of federal law.

First Circuit law bars the claims. Under First Circuit precedent (Stoutt v. Banco Popular de Puerto Rico, 320 F.3d 26 (1st Cir. 2003)), the fact that Fidelity acted in bad faith does not prevent it from claiming immunity under the BSA. The Stoutt court concluded that Congress easily could have added a good-faith requirement to the BSA but did not. Congress’ belief was that any qualification on the immunity created by the BSA would pose practical problems. The BSA immunizes financial institutions even if their disclosures are unfounded or even malicious, as long as they identify a possible violation of law. Even if the claimed violation of law is "impossible," immunity applies. The fact that the bank knew the Deutsches were innocent because it was covering up its own wrongdoing does not operate to bar immunity. The fact that several state courts have withheld BSA immunity from a SAR filer that acted in bad faith does not help the Deutsches, because the First Circuit is bound by the precedent in Stoutt.

The court pointed out that even if private actions are off the table, financial institutions that file malicious or intentionally false SARs are not untouchable because the federal government can go after them, with fines and prison time where appropriate.

The case is No. 18-1884.

Attorneys: David Graff (Graff Silverstein LLP) and Howard Graff (Arent Fox LLP) for AER Advisors, Inc., William J. Deutsch and Peter E. Deutsch. Christopher R.J. Pace (Jones Day) for Fidelity Brokerage Services, LLC.

Companies: AER Advisors, Inc.; China Medical Technologies, Inc.; Deutsch Family Wine & Spirits; Fidelity Brokerage Services, LLC

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