Prudential-Bache Securities, Inc. v. Citibank, N.A.

• Decision Date: 23 February 1989
• Docket Number: PRUDENTIAL-BACHE
• Citation: 539 N.Y.S.2d 699,73 N.Y.2d 263,536 N.E.2d 1118
• Parties: , 536 N.E.2d 1118, 57 USLW 2550, 7 UCC Rep.Serv.2d 1345 SECURITIES, INC., Appellant, v. CITIBANK, N.A., Respondent.
• Court: New York Court of Appeals Court of Appeals

Page 699

539 N.Y.S.2d 699

73 N.Y.2d 263, 536 N.E.2d 1118, 57

USLW 2550,

7 UCC Rep.Serv.2d 1345

PRUDENTIAL-BACHE SECURITIES, INC., Appellant, v. CITIBANK, N.A., Respondent.

Court of Appeals of New York.

Feb. 23, 1989.

William R. Mait, New York City, for appellant

Donald L. Cuneo, Henry Weisburg and Sharon Schroer, New York City, for respondent.

OPINION OF THE COURT

KAYE, Judge.

For more than two years, a massive fraud went undetected within Prudential-Bache, involving the issuance of firm checks that were regular on their face but improperly made payable to fictitious customers actually under the control of a Prudential-Bache employee. This case is an attempt by Prudential-Bache to recoup a portion of its losses from defendant, Citibank, one of the banks through which the employee laundered the proceeds of those checks. On Citibank's motion to dismiss the complaint, we conclude that no cause of action has been stated for conversion or money had and received, but that plaintiff has sufficiently pleaded a cause of action for "commercial bad faith" against the bank. We therefore modify the Appellate Division order that dismissed the entire action.

For purposes of this pleading motion, we accept as true the facts recited in plaintiff's complaint and other submissions. Beginning about the summer of 1981, John Efler, former section manager of Prudential-Bache's Dividend Department (which made dividend payments to record owners of securities held by the firm) caused the issuance of Prudential-Bache checks drawn on its account at Banker's Trust Company, and made payable to companies that were not actual Prudential-Bache customers but had names like them. Efler apparently accomplished this by creating false records, misinforming coemployees that proper claims had been presented, himself both requisitioning and approving the checks, and violating other Prudential-Bache procedures. For approximately two years, the checks were processed through Bank Leumi and then, beginning in May 1983, through defendant Citibank. Efler succeeded in embezzling approximately $18.9 million before the scheme was uncovered in October 1983. In two separate actions, Prudential-Bache has sought to recover its losses from the banks. At issue in this case is the approximately $3.7 million channeled through Citibank (see also, Prudential-Bach "Bache Sec. v. Bank Leumi, Sup.Ct., N.Y. County, May 20, 1985 [Wallach, J.], affd. without opn. 125 A.D.2d 1016, 508 N.Y.S.2d 360).

Between May and September 1983--the final months of the fraud--Efler induced Prudential-Bache to issue checks to M.N. Corporation and Harvard Corporation. M.N. and Harvard were not actual Prudential-Bache customers entitled to the dividends requisitioned for them by Efler, but shell corporations set up and controlled by Efler and his coconspirator, Lawrence Artese. Artese, not a Prudential-Bache employee, opened and maintained the accounts in the names of M.N. and Harvard at Citibank's Hudson Street branch for the purpose of depositing the checks and laundering the proceeds through them. To effect the scheme, the conspirators bribed two Citibank employees, Robert Hutchinson, an assistant manager, and Juanita Reyes, a customer service representative. Hutchinson was paid $65,000 in bribes and Reyes approximately $100,000, in return for which they set up the checking accounts at Citibank without proper opening account records and corporate resolutions, and with fictitious corporate officers; they further agreed not to prepare currency transaction reports, which must be filed with the Internal Revenue Service for cash transactions in excess of $10,000 (see, 31 U.S.C. § 5311 et seq.; 31 CFR 103.22[a] ).

Once the accounts were activated at Citibank's Hudson Street branch, Artese began a pattern of laundering funds there. Within the span of a few months at the branch, he personally moved more than $3.7 million in Prudential-Bache checks into the accounts and removed the funds in cash. Between May and September 1983, Artese deposited about $2.3 million to the account of M.N. and $1.4 million to the account of Harvard, and as soon as the checks cleared he drew out the funds. In all, Artese wrote some 100 checks, payable to cash, payroll or a nominal payee, often cashing several checks on a single day and leaving the branch with large quantities of currency or cashiers' checks. More than 20 of the checks were in amounts of $10,000 or just under (called "niners" because they skirted the requirement of currency transaction reports), and 40 or more were for larger amounts, some even exceeding $50,000; no currency transaction reports were prepared. Prudential-Bache asserts that other Citibank employees, including managers, were aware of these activities, through conversations with Artese on his near-daily visits to the branch and through cash distributions at teller windows.

In October 1983, Efler's supervisor conducted a review of account records and the scheme was exposed. Prudential-Bache testimony in another action, made part of the record before us, indicated that this review was precipitated by a tip, and that no internal audit of the Dividend Department had been conducted during the entire period of the fraud. On pleas of guilty, Hutchinson and Reyes were convicted in Federal Court of conspiring to make false entries on the books of Citibank with intent to injure and defraud Citibank, conspiring to defraud Citibank of their loyal and honest services as its employees through the payment of bribes, conspiring to cause the bank to fail to file currency transaction reports, and making false entries on the books of Citibank with intent to injure and defraud Citibank.

Prudential-Bache thereafter commenced the present action against Citibank, asserting claims of conversion, money had and received, and commercial bad faith, based on the bank's alleged facilitation of the scheme by enabling the conspirators to launder the proceeds. Citibank denied the material allegations of the complaint and asserted various affirmative defenses as well as three counterclaims. After submissions in which Prudential-Bache and Citibank each accused the other of gross supervisory failures and superior ability to thwart the scheme, Supreme Court granted both plaintiff's motion to dismiss the counterclaims and defendant's cross motion to dismiss or for summary judgment.

Supreme Court concluded that Prudential-Bache's complaint should be dismissed because the claims were barred by UCC 3-405(1)(c) and the common-law causes of action were insufficient in law. With respect to Prudential-Bache's cause of action sounding in "commercial bad faith," the court found that Citibank could not be held liable for the wrongdoing of Hutchinson and Reyes, because they were "adverse agents," as a matter of law; other Citibank employees would either be adverse agents as a matter of law if they participated with Hutchinson and Reyes, or merely negligent if they did not participate--in either event, not subjecting the bank to liability. A divided Appellate Division affirmed for the reasons stated by Supreme Court (141 A.D.2d 353, 529 N.Y.S.2d 983). ^* On Prudential-Bache's appeal, we now modify the Appellate Division order by restoring the cause of action for "commercial bad faith," and otherwise affirm.

Uniform Commercial Code § 3-405

We first consider UCC 3-405(1)(c), which was a basis for dismissal of the complaint.

The Uniform Commercial Code, in its rules governing check fraud, assigns losses by the relative responsibility of the parties for the loss. Losses arising out of forged indorsements are allocated to the party best able to take precautions to prevent them (see generally, McDonnell, Bank Liability for Fraudulent Checks: The Clash of the Utilitarian and Paternalist Creeds Under the Uniform Commercial Code, 73 Geo.L.J. 1399 [1985]; Comment, Allocation of Losses from Check Forgeries Under the Law of Negotiable Instruments and the Uniform Commercial Code, 62 Yale L.J. 417 [1953] ).

Ordinarily, an unauthorized indorsement--that is, either a forged indorsement or one made by an agent exceeding authority (UCC 1-201 [43] )--is ineffective to pass title or authorize the drawee bank to pay (see, 1 White & Summers, Uniform Commercial Code § 16-4, at 793 [Practitioner's--3d ed.] ). The check is not properly payable because an unauthorized signature is inoperative as that of the person whose name is signed (UCC 3-404; see also, Merrill Lynch, Pierce, Fenner & Smith v. Chemical Bank, 57 N.Y.2d 439, 444-445, 456 N.Y.S.2d 742, 442 N.E.2d 1253; Tonelli v. Chase Manhattan Bank, 41 N.Y.2d 667, 669-670, 394 N.Y.S.2d 858, 363 N.E.2d 564). Consequently, the drawee bank generally may not debit the drawer's account when it pays such a check. A drawee can, however, shift its loss to prior indorsers by way of an action for breach of warranty of good title (see, UCC 3-417, 4-207), with the loss ultimately placed on the forger or the party taking from the forger--that party being best positioned to identify the transferor as a wrongdoer, protect its own interests, and prevent the fraud (see, Underpinning & Found. Constructors v. Chase Manhattan Bank, 46 N.Y.2d 459, 468, 414 N.Y.S.2d 298, 386 N.E.2d 1319).

UCC 3-405(1)(c) creates an exception to the general principle that a drawer is not liable on an unauthorized indorsement. Known as the "fictitious payee" or "padded payroll" rule, UCC 3-405(1)(c) provides that an "indorsement by any person in the name of a named payee is effective if * * * an agent or employee of the maker or drawer has supplied him with the name of the payee intending the latter to have no such interest." Thus, in the very particular factual circumstances described by UCC 3-405(1)(c), the indorsement is treated as effective even though it is technically unauthorized, and the loss is allocated to the drawer-employer. (See generally, 1 White & Summers, op. cit., § 16-4; Triantis, Allocation of Losses From Forged...