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UNITED STATES FID. & GUAR. CO. v. FRB OF NEW YORK

October 9, 1985

UNITED STATES FIDELITY AND GUARANTY COMPANY and UNION TRUST COMPANY OF MARYLAND, Plaintiffs,
v.
THE FEDERAL RESERVE BANK OF NEW YORK, Defendant and Third-Party Plaintiff, v. STATE BANK OF ALBANY, PHILADELPHIA NATIONAL BANK and FIRST PENNSYLVANIA BANK, Third-Party Defendants (83 Civ. 3310-CSH) UNITED STATES FIDELITY AND GUARANTY COMPANY and UNION TRUST COMPANY OF MARYLAND, Plaintiffs, v. THE PHILADELPHIA NATIONAL BANK and FIRST PENNSYLVANIA BANK, Defendants (84 Civ. 6950-CSH)



The opinion of the court was delivered by: HAIGHT

MEMORANDUM OPINION AND ORDER

HAIGHT, District Judge:

Plaintiff Union Trust Company of Maryland ("Union Trust") and its insurer, United States Fidelity and Guaranty Company, brought this action to recover damages caused by a clever check fraud perpetrated upon Union Trust by a non-party. Following denial of its motion to dismiss, in an opinion reported at 590 F. Supp. 486 (hereafter cited as "USF&G I"), defendant Federal Reserve Bank of New York ("New York Fed") impleded third-party defendants State Bank of Albany ("Albany State"), *fn1" Philadelphia National Bank ("PNB"), and First Pennsylvania Bank ("First Penn"). Soon after filing of the third-party complaint, plaintiffs amended their complaint to assert claims against Albany State. It was unnecessary for them to assert claims against the remaining third-party defendants because the Court accepted for transfer and consolidation a suit which plaintiffs had previously filed against those two Pennsylvania banks in the Eastern District of Pennsylvania, United States Fidelity and Guaranty Co. v. Philadelphia National Bank, No. 83-1304 (E.D.Pa.). That action was redesignated civil action no. 84 Civ. 6950 (CSH) following the transfer.

 Since decision of the motion to dismiss, all parties have engaged in extensive revealing discovery. Following the completion of discovery, defendant New York Fed initiated the current round of motions by moving for summary judgment on plaintiffs' claims. Albany State filed a similar motion soon after. Plaintiffs opposed both motions and moved to amend their complaint against New York Fed. See note 9, infra. Also before the Court are three motions for summary judgment which are pending in Pennsylvania district court at the time of transfer of related case. These are cross-motions by plaintiffs and First Penn and a motion on plaintiffs' claims by PNB. Because the facts are for the most part undisputed, these motions together present most of the legal issues which would be encountered trial, if the complaints survive the present motions. I begin with a review of the facts revealed by discovery.

 I.

 As described more fully in USF&G I, 590 F. Supp. at 489-91, Union Trust was fraudulently induced to permit a depositor to withdraw funds against a worthless check. In April 1980, a man who called himself Marvin Goldstein established a checking account with Union Trust. Soon after, he deposited a check for over $880,000 in the account. The account upon which the check purported to be drawn did not exist, but a clever manipulation of the numerals on the face of the check caused it to be routed among a number of New york and Pennsylvania banks before being returned to Union Trust as uncollectible. In the meantime, Union Trust had permitted Goldstein to withdraw a substantial amount of case from his account, having assumed from the lapse of time that the check had been paid. *fn2" The foregoing information was pleaded in the original complaint, and discovery has confirmed its accuracy. The interesting details unearthed in discovery primarily concern not the behavior of the defendant banks in routing the bogus check but that of Union Trust's employees in accepting it and releasing funds against it. A summary of that new information follows.

 On April 16, 1980, Goldstein walked into a Baltimore branch of Union Trust. He told the branch manager, John Gemmill, that he and his father were precious metals dealers and that he planned to establish a Baltimore office of his father's New York business, Goldstein Precious Metals and Stones. In preparation, he sought to open a checking account with Union Trust in the name of the business. In opening the account, Goldstein produced one piece of personal identification, a New Jersey driver's license, and a New York certificate of business proprietorship, and supplied of New York bank reference. Gemmill recorded this and other information on a "New Account Information Form." Goldstein opened the new account with a cash deposit of $15,000.

 Gemmill then turned the new account form over to assistant branch manager John Clement with instructions to prepare two signature cards. Clement did so, he unaccountably neglected to transcribe the bank reference from the new account form to the signature cards. The form and one card were then sent to central Union Trust files, while on card was retained at the local branch.

 One week later, Goldstein returned to the branch and withdrew $14,000 from his account, reducing his balance to $1,000. Little was heard from him until May 6, when he deposited a check for $880,000 at a second Union Trust branch located a few blocks from the branch with which he had opened the account. Deposit of such a large check ordinarily triggers self-protective internal alerts at a bank, and Union Trust was no exception. Tellers who received for deposit checks over $100,000 were supposed to notify the branch manager, according to written Union Trust procedural guidelines. The manager was then to decide whether a "hold" should be placed on the check--that is, whether the depositor should be denied access to to the deposited funds for an extended period of time in order to permit the bank to confirm the collectibility of the check. In the absence of such a hold, funds ordinarily become available to the depositor within one to two days of deposit of the check. The teller who accepted Goldstein's check, however, neither notified bank officers of the large deposit nor placed a hold on it.

 The teller, however, was merely the bank's first line of defense against fraud. During the next few days, Gemmill, the branch manager, was reviewing a document known as a "balance fluctuation report," designed to alert bank officers to unusually large balance changes in the accounts under their supervision. The leap in the Goldstein Precious Metals account balance from one thousand to nearly a million dollars naturally caught his attention, and he decided to investigate. Gemmill first requested, or had Clement request, credit reports on the Goldstein business from two national credit reporting services. Both services reported that they had no record of Goldstein Precious Metals and Stones. Upon receiving this information, Gemmill had Clement retrieve the Goldstein signature card in order to pursue the credit references which would ordinarily be listed on it. Because Glement had neglected to transfer the reference from the account form, however, the signature card was no held, and neither bank employee pursued this further. *fn3"

 Wisely, Gemmill instructed Clement to look into the $880,000 check. The check was drawn on an account at First Penn of a company called metropolitan Investment Corporation. On instructions from Clement, an employee of Union Trust's credit department called officials at First Penn and was told that no such account existed. First Penn had no banking relationship with Metropolitan Investment Corporation. This information was relayed to Clement, who told Gemmill. All of the foregoing occurred on or before Friday, May 9, within four days of the check's May 6 deposit.

 According to his deposition testimony, Gemmill, who was leaving for vacation on May 9, told Clement to report to senior bank officers any activity in the Goldstein account, perhaps recognizing that the First Penn report made it unlikely that the goldstein check would be honored. Clement remembers no such instructions. Either way, no other action was taken at that time to prevent Goldstein from withdrawing funds against the check.

 On Monday, May 12, Gemmill was temporarily replaced by another bank officer. The next day, Goldstein telephoned Clement to ask instructions for making a "wire transfer" of funds, that is, for arranging the automatic transfer of funds from his account to an account in another bank. 'when Goldstein arrived at the branch to arrange for the transfer, he presented Clement with a bottle of expensive champagne. They discussed arrangements for the transfer, and Clement told him that the bank could only wire "collected" balances, that is, could only wire funds from the check after a sufficient time had passed to permit the bank to conclude that the check had been paid. *fn4" Apparently Goldstein was willing to wait. No further action was taken on Tuesday.

 Two days later, on Thursday, May 15, seven business days after deposit of the check, Goldstein returned and sought both to effect a wire transfer of $660,000 and to withdraw $95,000 in cash. The wire transfer was to be made to the account of a Maryland coin dealer. Apparently concluding that sufficient time had passed, Clement undertook to make the wire transfer. His first step was to check the Union Trust computer to find out whether sufficient funds were available in Goldstein's account to satisfy the transfer request. Because this act was crucial to the success of the fraud, it be examined in some detail

 As explained in note 4, supra, banks are never notified when checks deposited with them are paid by the payor bank. The large volume of checks in the banking system would make any such notification system expensive and unwieldy. if payment is refused, however, the payor bank must notify the depositary bank of the refusal within roughly twenty-four hours of its receipt of the check. See N.Y.U.C.C. § 4-302. In order to protect themselves against uncollectible checks, banks commonly guess at the amount of time the check is likely to spend in the collection system before reaching the payor bank and place a hold on the deposited check for at least that amount of time. Union Trust's computer was charged with keeping track of such holds.

 The Union Trust computer apparently registered two types of holds. When a check was deposited into a checking account such as Goldstein's, the Union Trust computer automatically placed a one- or two-day on the deposited check. These holds were keyed to the Federal Reserve clearing system. Member banks of the Federal Reserve system keep accounts with their local Federal Reserve bank. See USF&G I, 590 F. Supp. at 490 n.7. One of the functions of these accounts is to permit the Reserve bank to credit and debit member banks for checks cleared through the Reserve bank. Banks are ordinarily not given immediate credit for or access to the funds represented by checks such as that deposited with the Union Trust by Goldstein. *fn5" In other words, regardless of whether a depository bank gives its depositor immediate access to the funds represented by a deposited check, the Federal Reserve will not, in most instances, give the bank immediate credit for the check in the account which the bank maintains with the Reserve bank. Instead, the Reserve bank credits the check to a one-or two-day deferred account, equivalent to placing a hold on the check, with the length of the deferral depending primarily upon the distance the check must travel to reach the payor bank. Once the deferral period elapses, the Reserve bank grants the depositary bank a provisional credit for the amount of the check.

 In reality, however, checks frequently do not clear in the one- or two-day time period allotted for this purpose by the Federal Reserve. The provisional status of the credit given by the Reserve bank signifies that although a credit has been given to the account of the depositary bank, no corresponding debit has been made in the account of payor bank. Once the payor bank receives the check, it must notify the Reserve bank within twenty-four hours whether it will honor the check. If the Reserve bank is notified that the check has been honored, it debits the account of the ...


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