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NEW YORK/CHICAGO U.S. regulators on Wednesday launched the first lawsuit against a bank tied to the blow-up of brokerage Peregrine Financial, alleging U.S. Bancorp knowingly let Russell Wasendorf Sr. use customer money held at the bank to fund his lavish lifestyle.
Peregrine founder Wasendorf, who has been dubbed 'the Midwest Madoff' for his near two-decade long scheme, began serving a 50-year sentence in February for bilking $215 million from customers.
The lawsuit, brought by the U.S. Commodities Futures Trading Commission (CFTC), alleges a unit of U.S. Bancorp let Wasendorf secure loans and other funding against money it knew belonged to his brokerage's customers.
"(The bank) knowingly facilitated Wasendorf's transfers of millions of dollars of customers' funds out of this account to pay for Wasendorf's private jet, his restaurant, and his divorce settlement, among other things," the CFTC said in the lawsuit.
While former Peregrine clients were hopeful the lawsuit might help make them whole, legal experts said the lawsuit is also the most serious attempt yet by regulators to hold banks responsible for how they monitor customer funds placed with them by brokerages. They cautioned, however, that similar cases have faced a number of steep legal hurdles.
U.S. Bancorp spokesman Tom Joyce denied the allegations and said the CFTC case was an attempt to deflect attention from the regulator's failure to uncover Wasendorf's abuse of customer funds, which was discovered last summer after he wrote a confessional note prior to a botched suicide attempt.
"This lawsuit is without merit and represents an inappropriate attempt to reassign blame to U.S. Bank," Joyce said.
Michael Greenberger, a former director of the CFTC's trading and markets division, said that whatever the outcome of the case, banks were now on notice that regulators expect them to keep an eye on their brokerage clients.
"However this complaint turns out, I think it's going to be a lesson to depository institutions to take their responsibility seriously when they take in segregated account funds from futures commission merchants," Greenberger, who now works as a law professor, said.
"On its face it seems as if CFTC has a lot of evidence in its hands that go to the merits of this case," he added.
The CFTC complaint, filed in the U.S. District Court for the Northern District of Iowa, alleged U.S. Bank NA, a unit of U.S. Bancorp, accepted customer funds as security on multimillion dollar loans to Wasendorf, his wife and his construction company.
"Although the (account) was a customer segregated account containing Peregrine's customer funds, U.S. Bank ... treated the account as if it were a Peregrine commercial checking account."
The complaint is seeking permanent injunction, civil monetary penalties, and other equitable relief.
The revelation of the nearly two-decade long Wasendorf fraud last summer dealt another blow to confidence in the futures industry after the failure of MF Global in late 2011, and drew comparisons with New York money manager Bernard Madoff's massive Ponzi scheme due to the length of his deception. Madoff is serving a 150-year prison sentence.
The CFTC lawsuit singles out a female employee at the bank's Cedar Falls, Iowa branch, identified only as 'Banker A', for having particularly close dealings with Wasendorf.
"Throughout the relevant period, Banker A personally facilitated telephonic and inbranch deposits and wire transfers of Peregrine customer funds," the CFTC lawsuit said.
"Banker A and other U.S. Bank personnel perceived Wasendorf as a successful, desirable bank client with the potential to be a profitable, high growth client."
An earlier investigation into Wasendorf's fraud by the Berkley Research Group on behalf of the National Futures Association (NFA) named Hope Timmerman as the employee who handled the main Peregrine account at U.S. Bank.
Wasendorf Sr. said that he used little more than a rented post office box, Photoshop and ink jet printers to fake bank statements and hide money from regulators for years. He doctored the bank statements to show that accounts held more money than they actually did, while using clients' money to keep the company afloat and pay for his expensive home, private plane and extensive wine collection.
"U.S. Bank allowed Wasendorf to limit access to, and information about, an account holding millions of dollars of Peregrine's customer funds to only Wasendorf," the CFTC case said.
"Wasendorf was able to represent to the NFA and Peregrine's auditor that Peregrine maintained a customer segregated account at U.S. Bank that eventually contained more than $200 million, when in fact the average balance since May 2005 was only approximately $15.7 million," the CFTC case said.
MISSING CUSTOMER MONEY
Attain Capital chief executive, Jeff Malec, who saw his business drop by 80 percent after it lost money in the Wasendorf fraud, said he had been advising clients not to take buyouts of their claims "until and unless the big pockets in this case, U.S. Bank, is found innocent of any wrongdoing," he said.
"(A successful CFTC case) would be a huge plus for the futures industry in restoring the trust and faith in the customer segregated account structure," he added.
Other Peregrine customers, the majority of whom have received less than one-third of their money back, remained critical of the CFTC.
"It was the regulators who allowed all this to go on," said Joe Berger, who had $100,000 in a Peregrine account when the fraud came to light.
"Now regulators riding to my rescue at this date, I don't have a lot of confidence in them."
Peregrine Financial's trustee, Ira Bodenstein, is also contemplating a lawsuit against U.S. Bank to recoup customer funds. A lawyer for the trustee, Bob Fishman, said the CFTC lawsuit does not change that.
The outcome of the CFTC case could affect separate civil or class-action lawsuits, legal experts said, but they cautioned the case could take many years.
A previous attempt by regulators to sue the bank of failed brokerage Sentinel Management Group has been winding its way through the courts for more than five years.
But in 2012, JPMorgan paid $20 million to settle with the CFTC over its unlawful handling of customer segregated funds at Lehman Brothers in the wake of the broker-dealer's collapse during the financial crisis.
James Koutoulas, a lawyer and money manager, who co-founded the Commodity Customer Coalition to advocate for former MF Global and Peregrine customers offered cautious optimism on the CFTC suit on Wednesday.
"It's really the first ray of hope that we've seen for a while, and it's a good one," Koutoulas said of the complaint, describing the CFTC's case as "pretty damning".
U.S. Bancorp shares fell less than one percent to $35.01 on Wednesday, compared with a 1.69 percent decline in the S&P financial index.
(Additional reporting by Douwe Miedema in Washington and Ann Saphir in San Francisco; Editing by John Wallace, Matthew Lewis, Jeffrey Benkoe and Bernard Orr)
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