The huge fraud by that newest of North Carolinians, Bernard Madoff, cost hundreds of people billions of dollars. Who'll pay them back? Not Bernie; his Ponzi scheme, by its nature, made the money go poof.
But what about the advisers that steered clients to invest with Mr. Madoff? Surely they must make good their advisees' losses. Surely!
Not necessarily, and don't call Blawgletter Surely.
For today the Second Circuit threw cold water on the idea that Ponzi scheme victims can turn to their investment advisers for wholeness. The plaintiff, South Cherry Street, alleged that it put a lot of money into a hedge fund, Bayou Accredited, on the advice of Hennessee Group's Hedge Fund Advisory branch. But Bayou shared more with Ponzi than the number of letters in its name. It, too, paid off old investors with money from new ones until little remained. South Cherry blamed Hennessee for its loss, urging that its adviser recklessly touted Bayou. Had Hennessee done the due diligence it promised, South Cherry averred, it would've learned the truth and would've told South Cherry and nothing bad would've happened.
The district court dismissed South Cherry's securities fraud claim, holding that the complaint didn't allege intent to defraud — scienter — with enough oomph. The Second Circuit affirmed, saying:
It is far less plausible to infer that an industry leader that prides itself on having expertise that is called upon by Congress, that emphasizes its thorough due diligence process, that values and advertises its credibility in the industry — and evaluates 550 funds — would deliberately jeopardize its standing and reliability, and the viability of its business, by recommending to a large segment of its clientele a fund as to which it had made, according to South Cherry, little or no inquiry at all.
South Cherry Street, LLC v. Hennessee Group LLC, No. 07-3658-cv, slip op. at 32-33 (2d Cir. July 14, 2009). The panel thus held "an inference of negligence" more compelling than an inference of fraud.
Huh. We would've thought that vouching for a Ponzi scheme — actually vouching for it — pretty much makes you a reckless, grossly deficient, and very bad investment adviser. But the court gives Hennessee the benefit of of the doubt.
We wonder if Madoff cases will arouse the same sort of judicial empathy. We wouldn't count on it.