U.s. Bank National Association v. John Norton

• Court: Court of Appeals of Washington
• Decided: February 18, 2014
• Docket: 68531-7
• Status: Published

Opinion

IN THE COURT OF APPEALS OF THE STATE OF WASHINGTON

JOHN NORTON and KRISTINE NORTON, individually, and derivatively on behalf of LARCO-BOLIVAR No. 68531-7-1 INVESTMENTS, LLC, and SHELL LA PAZ, LLC; NORTHLAND CAPITAL DIVISION ONE LLC, individually, and derivatively on behalf of NDG-BRYCON, LLC; and P.R.E. ACQUISITIONS, LLC,

Respondents,

v.

U.S. BANK NATIONALASSOCIATION, PUBLISHED OPINION d/b/a U.S. BANK, .C- %8 2? n? 5§ n-J-i CO Appellant, FILED: February 18, 2014 oS CO ;£? j&.yr- and >3.

S ier— JOSE NINO DE GUZMAN and NDG *« ow o INVESTMENT GROUP, LLC, —. c;

Defendants.

Becker, J. — Before us on discretionary review is an order requiring a

bank to produce documents containing information about how the bank conducts

internal monitoring and investigations to detect fraud and money laundering.

Because such information is privileged from discovery under federal law, we No. 68531-7-1/2

conclude the trial court abused its discretion by ordering discovery and we

remand for entry of a protective order.

Jose Nino de Guzman is a former U.S. Bank employee. In 2006, he left

the bank to engage in real estate development in Peru through his investment

company, NDG Investment Group LLC. Plaintiffs John and Kristine Norton

invested $11 million. Some of the money they invested was deposited in

accounts held by Nino de Guzman and his company at U.S. Bank.

In 2009, the Nortons discovered that Nino de Guzman had been running a

Ponzi scheme and their money was gone. The Nortons brought suit against Nino

de Guzman and NDG Investment to recover their losses. Neither Nino de

Guzman nor NDG Investment is defending the action.

The Nortons added U.S. Bank as a defendant. Against the bank, the

Nortons alleged that when Nino de Guzman left the Bank's employ, he enlisted

other employees and paid them bonuses and commissions to help him solicit

investors; that the bank did not properly investigate or supervise its employees

who were simultaneously working both for the bank and for Nino de Guzman;

that money held by the bank in trust or fiduciary accounts was diverted into

personal accounts of Nino de Guzman; and that in the summer of 2008, the bank

initiated a money laundering investigation concerning Nino de Guzman and

became aware of the possibility that he was engaging in criminal activity but took

no action and continued to profit from his accounts. The Nortons' complaint

charged the bank with breach of fiduciary duty, securities violations, aiding and No. 68531-7-1/3

abetting fraud, conversion, unjust enrichment, consumer protection violations,

and negligent hiring, retention, and supervision.

In response to discovery requests by the Nortons, U.S. Bank produced

account statements and account opening documents for accounts belonging to

Nino de Guzman and his company, copies of the checks, and documentation of

international wire transfers. According to the Nortons, these documents showed

that Nino de Guzman opened over 30 accounts at U.S. Bank, through which he

circulated investor money to Peru and then back to his accounts. Some of his

checks were written to U.S. Bank employees. His accounts showed repeated

overdrafts.

The Nortons believed that Nino de Guzman's transactions aroused

suspicion and caused the bank to monitor his accounts and the accounts of the

employees. They made discovery requests for, generally, all documents

generated by the bank in internal investigations relating to Nino de Guzman's

accounts. For example, an interrogatory asked the Bank to describe "any due

diligence, investigation and/or inquiry conducted by or on behalf of U.S. Bank

regarding the background and/or conduct of Nino de Guzman and/or his Affiliated

Entities." Another interrogatory asked for the reason any such investigation was

initiated and asked the Bank to describe any action taken in response to such

investigation. As well, the Nortons asked for disclosure of the bank's methods

and policies for monitoring suspicious activity and detecting money laundering. No. 68531-7-1/4

The bank moved for a protective order on the ground that disclosure of

material responsive to these requests was prohibited by the Bank Secrecy Act,

31 U.S.C. § 5318(g). The bank asked the trial court to:

enter an order barring discovery of documents and information concerning (a) any alleged suspicious activity monitoring, investigation, or reporting conducted by U.S. Bank related to accounts held by Nino de Guzman or NDG at U.S. Bank, including but not limited to any documents or information that would reveal the existence or non-existence of any such investigation; and (b) the methods, policies and procedures U.S. Bank employs generally to monitor and detect for suspicious activity ....

The trial court denied the bank's motion for a protective order and ordered the

bank to respond fully.1 This order is before us on the bank's motion for discretionary review.

The issue involves interpretation of a statutory privilege. Our review is de

novo. Jane Doe v. Corp. of President of Church of Jesus Christ of Latter-Day

Saints. 122 Wn. App. 556, 563, 90 P.3d 1147 (2004). review denied. 153 Wn.2d

1025(2005).

Congress enacted the Bank Secrecy Act in 1970 to require national banks

to assist the government in monitoring for financial crimes. In 1992, Congress

gave the Comptroller of the Currency the power to require financial institutions to

report suspicious transactions to the federal government. 31 U.S.C. §

5318(g)(1); Union Bank of Calif, v. Superior Court. 130 Cal. App. 4th 378, 389, 29

Cal. Rptr. 3d 894 (2005). The statute also provides that banks may not notify

1The trial court denied U.S. Bank's request for oral argument. Given the complexity and sensitivity of the privilege issue, this is a case where oral argument likely would have been helpful. No. 68531-7-1/5

persons involved in the suspicious transaction that it has been reported. 31

U.S.C. § 5318(g)(2)(A).

Under the comptroller's regulations, each bank is required to "develop and

provide for the continued administration of a program reasonably designed to

assure monitoring compliance with the recordkeeping and reporting

requirements" of the act. 12 C.F.R. § 21.21(b). When a bank detects a known or

suspected violation of federal law or a suspicious transaction related to money

laundering, the bank must file a "Suspicious Activity Report" (also known as SAR)

to an officer or agency designated by the Secretary of the Treasury, using a form

prescribed by the comptroller. 31 U.S.C. § 5318(g)(1),(4); 12 C.F.R. § 21.11(a),

(b), (c). Specifically, banks must file a report when they suspect: (1) a bank

insider is involved, (2) violations aggregating $5,000 or more where a suspect

can be identified, (3) violations aggregating $25,000 or more regardless of

potential suspect, or (4) violations aggregating $5,000 or more involving potential

money laundering or violations of the Banking Secrecy Act. 12 C.F.R. §§

21.11(c)(1)-(4).

As provided by regulation, Suspicious Activity Reports are confidential.

Banks are prohibited from responding to a discovery request for a Suspicious

Activity Report or any information that would reveal the existence of a Suspicious

Activity Report.

(k) Confidentiality ofSARs. A SAR, and any information that would reveal the existence of a SAR, are confidential, and shall not be disclosed except as authorized in this paragraph (k). (1) Prohibition on disclosure by national banks—(i) General rule. No national bank, and no director, officer, employee, or agent of a national bank, shall disclose a SAR or any information that No. 68531-7-1/6

would reveal the existence of a SAR. Any national bank, and any director, officer, employee, or agent of any national bank that is subpoenaed or otherwise requested to disclose a SAR, or any information that would reveal the existence of a SAR, shall decline to produce the SAR or such information, citing this section and 31 U.S.C. 5318(g)(2)(A)(i), and shall notify the following of any such request and the response thereto: (A) Director, Litigation Division, Office of the Comptroller of the Currency; and (B) The Financial Crimes Enforcement Network (FinCEN).

12 C.F.R. § 21.11(k)(1)(i). The prohibition constitutes an "unqualified discovery

and evidentiary privilege" that cannot be waived. Whitnev Nat'l Bank v. Karam.

306 F. Supp. 2d 678, 682 (S.D. Tex. 2004). As stated in the regulation, the

privilege extends beyond the report itself to any information that would reveal

whether such a report exists.

The comptroller has declared compelling policy reasons for maintaining

the confidentiality of information that would reveal the existence of a Suspicious

Activity Report:

For example, the disclosure of a SAR could result in notification to persons involved in the transaction that is being reported and compromise any investigations being conducted in connection with the SAR. In addition, the OCC believes that even the occasional disclosure of a SAR could chill the willingness of a national bank to file SARs and to provide the degree of detail and completeness in describing suspicious activity in SARs that will be of use to law enforcement. If banks believe that a SAR can be used for purposes unrelated to the law enforcement and regulatory purposes of the BSA, the disclosure of such information could adversely affect the timely, appropriate, and candid reporting of suspicious transactions. Banks also may be reluctant to report suspicious transactions, or may delay making such reports, for fear that the disclosure of a SAR will interfere with the bank's relationship with its customer. Further, a SAR may provide insight into how a bank uncovers potential criminal conduct that can be used by others to circumvent detection. The disclosure of a SAR also could compromise personally identifiable information or commercially sensitive information or damage the reputation of individuals or companies No. 68531-7-1/7

that may be named. Finally, the disclosure of a SAR for uses unrelated to the law enforcement and regulatory purposes for which SARs are intended increases the risk that bank employees or others who are involved in the preparation or filing of a SAR could become targets for retaliation by persons whose criminal conduct has been reported.

Confidentiality of Suspicious Activity Reports, 75 Fed. Reg. 75,576, 75,578 (Dec.

3, 2010). As one court has stated, permitting the release of a Suspicious Activity

Report through civil discovery jeopardizes the law enforcement interests the act

was intended to promote. "Release of an SAR could compromise an ongoing

law enforcement investigation, tip off a criminal wishing to evade detection, or

reveal the methods by which banks are able to detect suspicious activity.

Furthermore, banks may be reluctant to prepare an SAR if it believes that its

cooperation may cause its customers to retaliate. Moreover, the disclosure of an

SAR may harm the privacy interests of innocent people whose names may be

contained therein." Cotton v. PrivateBank & Trust Co.. 235 F. Supp. 2d 809, 815

(N.D. III. 2002).

Conscious of the policy concerns that justify the privilege, courts have

refused to limit its coverage to documents that explicitly refer to Suspicious

Activity Reports. The comptroller has specifically recognized Cotton, Whitnev.

and Union Bank as cases that carry out the policy of the law—"namely, the

creation of an environment that encourages a national bank to report suspicious

activity without fear of reprisal." Confidentiality of Suspicious Activity Reports, 75

Fed. Reg. at 75,579 & n.23.

In Cotton, questions arose about how a bank handled securities that were

supposed to be held in trust to fund periodic payments under a structured No. 68531-7-1/8

settlement agreement. The securities were liquidated, and the funds were

diverted out of the trust. The bank became a defendant in a lawsuit in federal

court. Discovery requests were made to the bank for documentation of any

internal investigations of the account, including a request for all Suspicious

Activity Reports filed by the bank and for all documents relating "any inquiry or

investigation or review" conducted by the bank concerning accounts of the

parties involved. Cotton. 235 F. Supp. 2d at 811.

Like here, the bank resisted discovery based on the Bank Secrecy Act,

and the issue came before the court on a motion to compel. The court denied

the motion, noting first that Suspicious Activity Reports are absolutely privileged.

Cotton. 235 F. Supp. 2d at 814-15. The court next observed that under the

regulations, a bank is required to maintain files of Suspicious Activity Reports and

"any supporting documentation" for five years. Cotton. 235 F. Supp. 2d at 815,

quoting 12 C.F.R. § 103(18)(d). The court divided "supporting documentation"

into two categories. In the first category are factual documents which give rise to

suspicious activity. These items include "transactional and account documents

such as wire transfers, statements, checks, and deposit slips." Union Bank. 130

Cal. App. 4th at 391, citing Cotton. 235 F. Supp. 2d at 814. These documents

are to be produced in discovery "because they are business records made in the

ordinary course of business." Cotton. 235 F. Supp. 2d at 815. In the second

category are documents that are not to be produced in discovery "because they

would disclose whether a SAR has been prepared or filed." Cotton. 235 F. Supp.

2d at 815. This second category includes drafts of Suspicious Activity Reports or

8 No. 68531-7-1/9

"other work product or privileged communications that relate to the SAR itself."

Cotton, 235 F. Supp. 2d at 815. The documents at issue in Cotton were in the

second category and therefore were held not discoverable.

In Whitnev, law enforcement officials suspected the plaintiffs were

involved in illegal lending activities. The plaintiffs sued Whitney National Bank for

defamation on the theory that the bank had falsely accused them of illegal activity

in its communications to the government. They made a discovery request for

communications between the bank and government agencies relating to their

activities. The bank resisted, and the issue came before the court on the bank's

motion for a protective order. The plaintiffs acknowledged that they were not

entitled to receive copies of Suspicious Activity Reports or any information that

would reveal the existence of such a report, but they argued that other

communications between the bank and enforcement agencies were outside the

scope of the privilege. The court rejected the argument and granted the bank's

motion, finding that "the line defendants seek to draw is not one the cases

recognize." Whitney. 306 F. Supp. 2d at 682. The court held that the privilege

protects "a broader range of communications from production." Whitnev, 306 F.

Supp. 2d at 682. Communications to government agencies or officials about

suspected violations of the law are protected even if they do not culminate in the

filing of a Suspicious Activity Report:

The Whitney Bank Parties are protected from the production of communications they made to governmental agencies or officials reporting possible or suspected violations of laws or regulations by the defendants, or pertaining to such reports. Such communications may consist of a SAR itself; communications pertaining to a SAR or its contents; communications preceding the filing of a SAR and No. 68531-7-1/10

preparatory or preliminary to it; communications that follow the filing of a SAR and are explanations or follow-up discussions; or oral communications or suspected or possible violations that did not culminate in the filing of a SAR. The Whitney Bank Parties must produce documents produced in the ordinary course of business pertaining to the defendants' banking activities, transactions, and accounts, but may not produce documents or information that could reveal whether a SAR or other report of suspected or possible violations has been prepared or filed or what it might contain, or the discussions leading up to or following the preparation or filing of a SAR or other form of report of suspected or possible violations.

Whitnev. 306 F. Supp. 2d at 682-83.

In Union Bank, the plaintiffs were investors who alleged they were

defrauded in a Ponzi scheme. They sued the bank that opened and operated the

trust accounts that were allegedly looted, making claims similar to the Nortons'.

The plaintiffs first attempted, unsuccessfully, to obtain any Suspicious Activity

Reports the bank had filed with the government. In the course of discovery, the

plaintiffs discovered that the bank had its own internal procedures to identify,

register, and describe what might constitute suspicious activity. In particular, the

bank had its own "Form 00244" for internal communications about suspicious

activity. Union Bank, 130 Cal. App. 4th at 386. The plaintiffs made a discovery

request for every Form 244 related to the accounts at issue. The bank resisted,

and the issue came before the trial court on the plaintiffs' motion to compel. The

trial court granted the motion, reasoning that a routine bank form used by the

bank for internal purposes would not necessarily reveal that a Suspicious Activity

Report had been prepared or filed.

The California Court of Appeals granted discretionary review and directed

the trial court to vacate its order. Looking at the substance of Form 244, the

10 No. 68531-7-1/11

court concluded that it was part of the process the bank used to comply with the

comptroller's regulations that require reporting suspicious activity. Union Bank,

130 Cal. App. 4th at 394-95. "Unlike transactional documents, which are

evidence of suspicious conduct, draft SAR's and other internal memoranda or

forms that are part of the process of filing SAR's are created to report suspicious

conduct." Union Bank, 130 Cal. App. 4th at 391. "A bank's internal procedures

may include the development and use of preliminary reports subject to various

quality control checks before the bank prepares the final SAR that will be filed.

Revealing these preliminary reports, the equivalent of draft SAR's, would disclose

whether a SAR had been prepared." Union Bank. 130 Cal. App. 4th at 392.

The Union Bank court was mindful of the general rule that "evidentiary

privileges should be narrowly construed because they prevent otherwise

admissible and relevant evidence from coming to light." Accordingly, the court

observed that a bank "may not cloak its internal reports and memoranda with a

veil of confidentiality simply by claiming they concern suspicious activity or

concern a transaction that resulted in the filing of a SAR." Union Bank, 130 Cal.

App. 4th at 392. The Nortons cite this language as authority for their argument

that the privilege does not cover internal investigations and monitoring. What

they overlook is that the Union Bank court proceeded to hold that the privilege

does cover the bank's internal reports of its investigations of suspicious activity,

even if the internal reports are not communicated to federal authorities. Union

Bank, 130 Cal. App. 4th at 392.

11 No. 68531-7-1/12

The comptroller states that the Bank Secrecy Act privilege reaches "to

material prepared by the national bank as part of its process to detect and report

suspicious activity." Confidentiality of Suspicious Activity Reports, 75 Fed. Reg.

at 75,579. The cases discussed above support the comptroller's interpretation.

The privilege is not limited to documents that contain an explicit reference to a

Suspicious Activity Report. It covers documents related to a bank's internal

inquiry or review of accounts at issue (see Cotton, 235 F. Supp. 2d at 811),

communications between a bank and law enforcement agencies relating to

transactions conducted by the person suspected of criminal activity (see

Whitney. 306 F. Supp. 2d at 682-83), and internal forms used in a bank's process

for detecting suspicious activity that must be reported (see Union Bank. 130 Cal.

App. 4th at 395).

Against this background, the Nortons seek disclosure of documents

relating to internal monitoring and investigations conducted by the bank to detect

fraud and money laundering. They have requested the names of bank

employees who were in charge of or involved in any internal investigation into the

transactions involving Nino de Guzman and his company. They want the bank to

divulge the details of the system of alerts it uses to track its customers' banking

activities. They contend that conflict with the regulations under the Bank Secrecy

Act can be avoided by redacting from the documents any explicit reference to a

Suspicious Activity Report.

The Bank Secrecy Act privilege cannot be enforced merely by redacting

explicit references to the existence of a Suspicious Activity Report. Requiring

12 No. 68531-7-1/13

U.S. Bank to disclose information about internal investigations or monitoring of

the Nino de Guzman accounts in particular, or internal methods of tracking

unusual patterns in banking activity in general, would reveal the existence of a

Suspicious Activity Report and would undermine public policy. Just as disclosure

of a Suspicious Activity Report "may provide insight into how a bank uncovers

potential criminal conduct that can be used by others to circumvent detection,"

Confidentiality of Suspicious Activity Reports, 75 Fed. Register 75576-01, at

75578 (Dec. 3, 2010), so too will disclosure of what kinds of transactions trigger

internal "red flag" alerts. Revealing the names of bank personnel involved in

internal investigations potentially makes them targets for retaliation by persons

whose criminal conduct has been reported.

The banks are required by statute to establish internal policies,

procedures, and controls to detect and report money laundering. 31 U.S.C. §

5318(h); Union Bank, 130 Cal. App. 4th at 392. Any internal system a bank has

established for detecting and investigating money laundering will, however it is

labeled, be intertwined with the bank's obligation to report suspicious activity to

the government. Discovery into these matters will produce documents

suggesting that a Suspicious Activity Report has been or might be under

consideration or has already been filed. In Whitnev, the court barred discovery of

"discussions leading up to or following the preparation or filing of a SAR or other

form of report of suspected or possible violations." Whitney, 306 F. Supp. 2d at

683. Similarly here, and for the same reasons, we hold that U.S. Bank may not

13 No. 68531-7-1/14

be ordered to describe or disclose its internal investigations, either generally or

those specifically related to this case.

As discussed above, Cotton held that factual documents that support the

filing of a Suspicious Activity Report are discoverable "because they are business

records made in the ordinary course of business." Cotton. 235 F. Supp. 2d at

815. The Nortons argue a bank's reporting of suspicious activity should be

discoverable to the extent it is done in the ordinary course of business. This is

an unpersuasive attempt to escape the line drawn in Cotton. Internal reports and

methods used to investigate suspicious activity are precisely the type of

documentation Cotton indicated was within the second, undiscoverable type of

supporting documentation.

The Nortons suggest that at a minimum, U.S. Bank should be required to

submit documents concerning internal investigations for in camera inspection by

a judge who would then determine whether the documents are privileged. But

there is no reason to believe that the bank is withholding discoverable

documents. The bank has produced ordinary business records, including wire

transfers, statements, checks, and deposit slips. The bank has produced

account opening statements displaying the names of the employees who were

involved in opening the accounts. The bank has also produced some sections of

its operating procedures manuals and employee training materials. The only

type of information the bank has refused to produce that the Nortons claim is

outside the privilege is information about the bank's internal investigations and

monitoring of suspicious activity. Under the Bank Secrecy Act, that information is

14 No. 68531-7-1/15

privileged. We conclude the Nortons have not articulated a basis for requiring in

camera review.

U.S. Bank moved to strike the Nortons' brief of respondent under RAP

10.7 because it includes various extraneous, irrelevant, and unauthenticated

materials from the internet and from unrelated trial court proceedings that are

outside of the record under review. We have not considered the materials that

the Nortons improperly included in their brief, and we therefore need not address

the motion to strike. The bank's motion for attorney fees and sanctions under

RAP 10.7 is denied.

Reversed and remanded for entry of a protective order as requested by

the bank.

^W-J^?/?; WE CONCUR:

^ J^g^