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Frederick v. Smith

416 N.J. Super. 594, 7 A.3d 780 (App. Div. 2010)

CONSUMER FRAUD; NEGLIGENCE —When a brokerage firm, derives no financial benefit from its actions, and only deposits checks into a con man’s account as directed by its customer, no relationship is created between the brokerage firm and the person sending the money that would impose a duty upon the brokerage firm to monitor its customer’s account for fraud.

Individual investors were persuaded by a con man to invest in a fictitious entity. As part of the fraud, the investors were instructed to invest their funds by paying them to an account maintained with a brokerage firm by the con man. The investors were told to make their checks payable to his account or directly to the brokerage firm. The con man then sent the investors phony correspondence memorializing the deposit and used the funds for his own benefit. All told, the investors invested approximately $10,000,000. By the time they discovered the fraud, the investors lost almost all of their money.

The investors sued the brokerage firm for negligence, but the lower court dismissed the suit. It found that because the investors had no relationship with the firm and the con man had no relationship with the brokerage firm other than as an account holder, the brokerage firm owed no duty to the investors. The investors appealed, but the Appellate Division affirmed.

The investors claimed that the brokerage firm was aware, or should have been aware, that a ponzi scheme was taking place. They also claimed that because they wrote checks directly to the brokerage firm in connection with their investment in a fictitious entity, the brokerage firm was a fiduciary and owed a duty of care to them to discover, and alert them about the ponzi scheme. The Court noted that in deciding whether to impose a duty, a court must determine: if imposing a duty is fair based on the relationship of the parties, the nature of the risk, and the public interest in imposing the duty. It also noted that the New Jersey Supreme Court had previously expressed a reluctance to impose a duty of care on banks toward total strangers. Thus, the Court rejected their argument, finding that without an agreement, undertaking or contract between the brokerage firm and the bank, the brokerage firm owed no duty to the investors to periodically or regularly police the account of its account holders for indicia of fraud. Further, just because the investors, at times, would make investments payable directly to the brokerage firm (as instructed by the con man) this would not create a relationship between the investors and the brokerage when none previously existed. The brokerage firm deposited checks into the con man’s account as directed by its customer; it did not issue any statement to the investors; and, it did not derive any financial benefit from the fact that checks were written directly to the brokerage firm instead of to the con man. Therefore, the brokerage firm had no relationship with the investors that would impose a duty upon it to monitor for fraud.

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