Ponzi scheme losses to Ohio bank are insurable, court rules

By Doug Bailey

AIG’s claim that a bank’s losses from a Ponzi scheme run by one of its customers were not insurable has been overturned by a Cincinnati appellate court, seemingly bringing an end to a long and sordid case that cost the bank millions.

The case dates back to 2002 when Huntington National Bank in Columbus, Ohio, approved multiple lines of credit to two companies later found to be fraudulent.

Cyberco Holdings Inc. and Teleservices Group were ostensibly computer servicing companies in need of working capital. Instead, they were paper companies created by a bank customer, Barton Watson, according to court filings. Watson borrowed money from financing companies and instructed them to send the money directly to Teleservices, the company’s supposed vendor, to pay for computer equipment. Once the financing companies paid Teleservices, Watson took the money from Teleservices’ bank account and deposited it into Cyberco’s account at Huntington.

Huntington grew suspicious in September of 2003 following a number of large deposit transfers from Teleservices to Cyberco. Watson told the bank Teleservices was a company acquisition, which contradicted previous assertions that the company was a vendor. Cyberco also refused to participate in some of the bank’s authentication services and never gave the bank an audited financial statement, as required.

Nevertheless, the bank continued the financial relationship, even extending more credit to the company to cover huge overdrafts. Finally, in April 2004, Huntington found obvious discrepancies in Cyberco’s financial statements and reported the issues to its security department, which discovered the FBI was investigating Watson who had confessed to and served time for fraud-related activity. The security department, however, did not disclose this information to the bank’s officers and between May and October of 2004, Cyberco repaid its entire loan. Shortly thereafter, Watson committed suicide.

But that wasn’t the end of the bank’s problems.

Perpetuation of Ponzi scheme alleged

Creditors of Cyberco and Teleservices discovered the companies were bankrupt and accused Huntington of perpetuating the Ponzi scheme by making sure its loans were repaid before blowing the lid off the illegal activities, thus wrongfully putting its desire to be repaid ahead of its concern that Watson was committing crimes. The bankruptcy trustees accused the bank of participating in the fraudulent transfers and sought recovery from Huntington.

The bankruptcy proceedings were long and complex, with the trustee seeking to recover money transferred into Cyberco’s Huntington account and the bank arguing the transfers were not recoverable because it accepted them in good faith under current law.

The case wound its way thorough the courts with the bank contending its liability was limited to $12.8 million and Huntington arguing that because the bank had prior knowledge of fraudulent activity it was liable for $36 million in liability. Eventually, in March of 2018, Huntington settled with the trustee for $32 million.

But that still didn’t bring an end to proceedings.

Huntington filed a demand claim with its insurer AIG to recover $15 million of the losses – the maximum amount under the terms of its policy – but was denied. Huntington then sued AIG claiming breach of contract and bad faith. AIG claimed Huntington’s settlement payment was not a “loss” under the policy terms and the circuit court agreed.

AIG argues against insurability

“Huntington suffered no insurable loss when it returned funds it was never lawfully entitled to receive in the first place,” AIG attorneys argued. “This conclusion follows from the policy’s unambiguous text that ‘Loss’ shall not include matters deemed uninsurable under the law, and the consensus of authority holding that public policy precludes insurance for the disgorgement of wrongfully acquired funds.”

But on appeal, Huntington argued that its claim was insurable and should be resolved in its favor. Earlier this month, the appellate court agreed and overturned the lower court’s decision.

“Ohio law demonstrates that for insurance coverage to be uninsurable, the damages claimed must be based on an intent to injure, malice, ill will, or other similar culpability,” the three-party panel of judges ruled. “Huntington argues the settlement payments to the trustee are insurable because the settlement payment was not akin to punitive damages and was not intended to punish and intentional act. We agree.”

Attempts to reach Huntington attorneys for comment were unsuccessful.

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].