Corporate

Money Laundering Allegations and Follow-On Securities Litigation

 In the wake of the 9/11 terrorist attacks, Congress enacted or expanded a number of laws regarding the global financial system in order to combat money laundering and promote national security. As I have noted in prior post (most recently here), regulatory enforcement activity under these laws represents a potentially significant new area of potential D&O exposure. In addition, as a recently filed securities class action lawsuit shows, alleged violations of these financial controls not only can lead to regulatory action by federal regulators but may also lead to private civil litigation.

Background

The recently filed securities class action lawsuit involves BofI Holdings, Inc., the holding company of Bank of the Internet USA. The bank was the subject of an August 22, 2015 New York Times article entitled “An Internet Mortgage Provider Reaps the Rewards of Lending Boldly” (here). The Times article reports that the bank has enjoyed great business success and rapid growth in recent years by “issuing big mortgages to high earners whom other lenders might not necessarily welcome with open arms.”

While the bank has enjoyed substantial success, it apparently has its critics. Among other things, the news article reports, the bank “has lent some money to some unsavory characters,” including individuals convicted of Medicare fraud and of securities fraud. The news article also reports that “there are questions” about the bank’s “marketing of itself as a lender to ‘foreign nationals.’” The article noted that this kind of lending activity can attract increased scrutiny from banking regulators under bank secrecy and anti-money-laundering laws, and noted further that in recent months there had been “unrest” with its regulatory compliance division, including the departure, among others, of an internal audit division employee named Matt Erhart.

An October 13, 2015 New York Times article (here) reported that Erhart had filed a lawsuit against the bank alleging that he had been fired after revealing what he believed to be wrongdoing at the bank to federal regulators and management at Bank of Internet. Erhart alleged that the bank had violated federal laws protecting whistleblowers from retaliation. Among other things, Erhart’s complaint alleges that Bank of Internet’s borrowers may have included foreign nationals who might have been off-limits under federal anti-money-laundering laws.

On October 15, 2015, BofI Holding issued a press release disputing the allegations, which had been repeated in media reports. The press release quotes the company’s CEO as saying “The complaint recycles old, baseless and factually inaccurate allegations from a junior audit team member no longer employed at the Bank. Having shopped his allegations to a variety of regulatory agencies who have taken no action, Mr. Erhart decided to file this meritless lawsuit.”

The Lawsuit

On October 15, 2015, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of California against BofI Holding, its CEO, and its CFO. Plaintiff’s counsel’s October 15, 2015 press release about the lawsuit can be found here. The plaintiff’s complaint, which can be found here, quotes at length from the August New York Times article and from Erhart’s lawsuit. The complaint alleges that:

defendants made false and/or misleading statements and/or failed to disclose that: (i) the Company’s internal controls were frequently disregarded; (ii) Bank of Internet’s borrowers included foreign nationals who should have been off-limits under federal anti-money-laundering laws; (iii) many Bank of Internet accounts lacked required tax identification numbers; (iv) Bank of Internet fired an internal auditor who raised the foregoing issues to management and to federal regulators; and (v) as a result of the above, the Company’s statements regarding its internal controls and other financial statements were materially false and misleading at all relevant times.

Among other things, the complaint also alleges that following the news of the lawsuit, the holding company’s share price declined 30%. The complaint, which purports to be filed on behalf of a class of shareholders who purchased their shares between September 4, 2013 and October 13, 2015, alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

Discussion

The case presents an interesting example of an instance where an alleged violation of the federal anti-money-laundering laws has given rise to a D&O claim. The case also involves the unusual circumstance where money-laundering violations have been raised but apparently are not in fact actually being pursued by the banking authorities.

As I noted in a prior post, the costs of responding to and defending against allegations of alleged violations of federal financial controls could fall within the coverage of the target company’s D&O insurance policy. And as I noted in a separate prior post, there have been cases where private civil litigation, in the form of a shareholder derivative lawsuit, has arisen in connection with a company’s payment of fines U.S. Department of Treasury’s Office of Foreign Assets Control (OFAC) for alleged trade sanction violations.

The securities class action lawsuit filed recently filed against BofI Holding represents another example where alleged violations of federal laws relating to money laundering and national security have led to claims potentially covered under a D&O insurance policy. While the kinds of regulatory fines and penalties that violations of these laws might trigger typically would not be covered under D&O insurance policy, the type of D&O lawsuit filed against BofI Holding typically would be covered, which highlights the way in which these kinds of allegations can lead both to D&O claims and to potentially covered losses.

The lawsuit raises the possibility of a potentially significant new liability exposure for directors and officers of companies allegedly engaging in transactions subject to federal money laundering and national security laws. The lawsuit also raises the prospect of further follow-on civil litigation arising in the wake of whistleblower allegations of federal regulatory violations.

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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