Second Amended Complaint

Leslie A. WHITTINGTON, Terry R. Sloan, Linnea J...., 2013 WL 10945133...

2013 WL 10945133 (N.C.Super.) (Trial Pleading) Superior Court of North Carolina. Superior Court Division Twenty-Eighth Judicial Circuit Buncombe County

Leslie A. WHITTINGTON, Terry R. Sloan, Linnea J. Dallman, Jeffrey D. Efird, Melissa Efird, Jennifer F. George, Pamela J. Hawes, Jane S. Jones, Queen C. Miller, Patricia Ream, Richard Ream, Donglas Watkins, Jeanne West Watkins, David West, Mary West, Sandra Hoskin, Carroll C. Bridges, Phyllis Rae Bridges, Harold R. Parris, Wylma H. Parris, Victoria B. Henson, Rhonda Blankenship, and Carroll D. Blankenship, Plaintiffs, v. MORGAN STANLEY SMITH BARNEY, William Kimbrough, and Hometrust Banking Partnership F/k/a Home Trust Bank, Defendants.

No. 2012CVS01206. January 19, 2013.

(ury Trial Demanded)

Second Amended Complaint

John B. Veach III, N.C. Bar No. 26385, H. Naill Falls Jr., Johanna S. Fowler, N.C. Bar No. 24679, Falls & Veach, 20 Cedarcliff Road, Asheville, North Carolina 28803, Telephone: (828) 277-6001, Facsimile: (828) 277-6088, tv @fallsveach.com, [email protected].

By and through their undersigned counsel, Plaintiffs submit this Second Amended Complaint, which differs from the Amended Complaint in that two additional Plaintiffs, Carroll D. Blankenship and Rhonda Blankenship are added to the case, as follows:

A. Nature of the Action

1. This action arises out of the Plaintiffs' collective losses of millions of dollars in a ponzi scheme operated by William Bailey through a company called Southern Financial Services in Asheville, North Carolina (the “Southern Financial Ponzi Scheme”). Because Southern Financial Services was not a bank, Mr. Bailey deposited Plaintiffs' monies and that of other investors in accounts at Defendants' Morgan Stanley Smith Barney (“MSSB”) and Home Trust Bank (“Home Trust”). Defendants facilitated the operation of the Southern Financial Ponzi Scheme by failing to act on obvious “red-flags,” which were apparent to Defendants from Mr. Bailey's handling of the accounts.

2. Beginning in early 2002 and culminating with the collapse of the Southern Financial Ponzi Scheme in late 2010, Mr. Bailey moved millions of dollars back and forth through accounts at Defendants' offices. These transactions earned Defendants lucrative fees and commissions.

3. The Southern Financial Ponzi Scheme collapsed on November 30, 2010, when Mr. Bailey bounced three kited checks worth $4.8 million in the account at Home Trust Bank. These checks had been shuttled back and forth between the Home Trust and MSSB accounts. At this time at least one Plaintiff went to MSSB's Asheville office and requested the return of her money held in the MSSB accounts of Southern Financial. She was told that the computers were turned off, her money was gone, and she should expect a call from MSSB's lawyer in New York City.

4. The United States Attorney for the Western District of North Carolina instituted federal criminal charges against Mr. Bailey on or about February 4, 2011, On or about February 18, 2011, in this Court, Mr. Bailey pled guilty to charges of securities fraud, mail fraud and filing false income tax returns. He awaits sentencing and faces up to 43 years in prison.

5. Plaintiffs bring this action seeking monetary damages and restitution from Defendants because they permitted Mr. Bailey to continue his operations through the use of their business and professional services while knowingly disregarding his banking and check writing activities, which were clearly suspicious and raised multiple “red-flags.” Defendants knowingly disregarded these suspicious financial activities of Mr. Bailey while providing him an imprimatur of legitimacy to Plaintiffs, thus furthering Plaintiffs' disastrous losses, as will be shown more fully herein. Defendants knowingly disregarded that Mr. Bailey's banking activities had all the earmarks of a Ponzi scheme facilitated through accounts held by Defendants.

B. Parties

6. Plaintiffs Phyllis Rae Bridges, Carroll C. Bridges, Leslie A. Whittington, Jennifer F. George, David West, Mary West, Pamela Jean Hawes, Sandra Hoskin, Linnea J. Dallman, Jeffrey D. Efird, Melissa Efird, Harold R. Parris and Wylma H. Parris are citizens and residents of the State of North Carolina, County of Buncombe. Melissa Efird LLC is an entity set up by Mr. Bailey through Southern Financial. The West Family LLC and The West Family Real Estate Investment Trust also are entities set up by Mr. Bailey through Southern Financial. Mary West is the Trustee of the West Family Real Estate Investment Trust.

7. Plaintiff Victoria B. Henson is a citizen and resident of the State of North Carolina, County of Haywood.

8. Plaintiffs Jeannie West Watkins and Douglas Watkins are citizens and residents of Sharp County, Arkansas,

9. Plaintiff Terry R. Sloan is a resident of Anderson, Anderson County, South Carolina.

10. Plaintiffs Queen C. Miller and Jane S. Jones are citizens and residents of Aiken County, South Carolina. Jane S. Jones is the trustee of the Queen C. Miller Irrevocable Trust set up by Mr. Bailey through Southern Financial Services.

11. Plaintiffs Patricia Ream, Richard Ream and Pamela J. Hawes are citizens and j residents of Transylvania County, Brevard, North Carolina.

12. Plaintiffs Carroll D. Blankenship and his wife Rhonda Blankenship are citizens and residents of Oconee County, Seneca, South Carolina.

13. Defendant Morgan Stanley Smith Barney LLC is a limited liability company with offices throughout the United States. It is a Delaware corporation with its principal place of business in New York, New York. It has numerous offices in North Carolina, including its office on Charlotte Street, Asheville, North Carolina, which is the subject of this action.

14. Defendant Home Trust Bank is a member of a mutual multi-bank partnership spanning the State of North Carolina. It has four offices in Asheville, North Carolina, including the location at 11 Woodfin Street, Asheville, North Carolina where Mr. Bailey's primary contacts with the Bank occurred. According to published reports, Home Trust Bank's participation in the fraud scheme resulted in an after-tax charge of $2.7 million and the Bank absorbed the loss for a profit of $5.7 million in 2010.

15. Defendant William Kimbrough is a Financial Advisor, First Vice President, Senior Investment Management Consultant, and Ceritified Financial Planner employed by Defendant Morgan Stanley Smith Barney at its office located on 500 College Street, Asheville, North Carolina. Upon information and belief, he is a citizen and resident of Asheville, Buncombe County, North Carolina. At all times relevant to this action, Mr. Kimbrough was the Morgan Stanley Smith Barney financial advisor/ brokerage account representative for the Southern Financial Services financial management accounts at Morgan Stanley Smith Barney. He worked closely with Mr. Bailey in this regard.

C. Jurisdiction and Venue

16. Plaintiffs are citizens of North Carolina, South Carolina and Arkansas. Defendant Smith Barney is a Delaware corporation with offices in Asheville, North Carolina. Defendant Home Trust Bank is a North Carolina banking partnership with its principal bank office in Asheville, North Carolina. Defendant Kimbrough is a citizen and resident of Asheville, North Carolina. Venue properly lies in this Court because this action concerns acts and omissions which have primarily occurred and continue to occur in Asheville, Buncombe County, to the detriment of Plaintiffs.

D. Factual Allegations

1. Plaintiffs' Dealings With Bailey and Southern Financial

17. Bailey held himself out to the public as an experienced investment advisor.Through Southern Financial he offered investment services, trust formation, 1031 exchange programs, alternative IRA programs and other related financial services. Plaintiffs and other investors were told that Southern Financial maintained accounts at Home Trust and MSSB and that their investments would be held or facilitated through these companies. For example, Southern Financial customers knew that real estate related transactions would generally be handled through Home Trust and that securities investments and money market accounts were being handled by MSSB.

18. Unknown to Plaintiffs at the time they engaged Mr. Bailey and Southern Financial, and on all occasions when Plaintiffs entrusted funds to Mr. Bailey and his company, Mr. Bailey was carrying on a criminal enterprise, and he did not intend to invest Plaintiffs* assets appropriately, but, rather, intended to misappropriate Plaintiffs' funds and/or use them in an unauthorized and unlawful manner.

19. In early 2011, Plaintiffs learned that Mr. Bailey had stolen all of the money that Plaintiffs transferred to him. It is unlikely that Plaintiffs will be able to recoup any of their investments.

20. As of the discovery of the Bailey Ponzi Scheme, Plaintiffs had advanced funds and entrusted to Mr. Bailey and Southern Financial, and thus Defendants, millions of dollars. Those funds consisted of approximately the following:

(a) From an initial investment of approximately $95,000 made from 2002 to 2010, Plaintiffs Phyllis Bridges and Carroll Bridges have lost their entire life savings of $150,000;

(b) From an initial investment of $1,263,000 made in 2006, Plaintiffs Leslie A. Whittington and Jennifer F. George have lost approximately $742,000;

(c) From an initial investment of $6 million made in 2009, Plaintiffs David West, Jeanne West Watkins, Douglas Watkins, and Mary West, collectively, have lost virtually the entire sum of $6 million;

(d) From an initial investment of $20,000 made in 2002, Plaintiff Linnea Dallman has lost approximately $ 20,000;

(e) From investments of $600,000 made in 2009-2010, Plaintiffs Jeffrey D. Efird, Melissa Efird have actual and projected future losses of approximately $1.5 million;

(f) From investments made from 1994 until 2001, totaling approximately $1.3 million, Plaintiff Terry R. Sloan has actual and projected future losses of approximately $3.8 million;

(g) From investments made in 2003 to 2005 of approximately $136,000, Plaintiffs Jane S. Jones and Queen C. Miller, collectively have losses of approximately $133,400;

(h) From investments made during the past 10 years, Plaintiffs Patricia Ream and Richard Ream have lost the entire sum of approximately $600,000;

(i) From investments made from 2005 through 2010, Plaintiff Pamela J. Hawes has lost the entire sum of approximately $161,000;

(j) From investments of $15,000, Plaintiff Sandra Hoskin has lost the entire amount;

(k) From investments beginning in 1993 and continuing through 2010, Harold R. Parris and Wylma H. Parris has lost the entire sum of approximately $518,025;

(l) From investments of $1,187,500 made from 2003 to 2010, Plaintiff Victoria B. Henson has lost $826,200; and,

(m) From investments made from 2005 to 2010, Plaintiffs Carroll D. and Rhonda Blankenship lost approximately $202,000.

In sum, Plaintiffs' collective losses exceed $13 million.

21. In 2011, in connection with his guilty plea, plaintiffs discovered the nature and extent of the relationship between Defendants, Mr. Bailey and Southern Financial, which led to discovery of facts that provide the basis for the claims asserted in this complaint. In addition counsel for Plaintiffs interviewed Mr. Bailey in Asheville, North Carolina on May 25, 2011 to determine additional facts and circumstances supporting the allegations contained herein. A court reporter recorded the interview and produced a transcript, which is in the possession of counsel for Plaintiffs.

22. In this interview Mr. Bailey provided details of his transactions between Home Trust Bank and MSSB. In particular, he stated that he wrote checks transferring large sums of money, millions of dollars, back and forth from the brokerage account at MSSB to the Southern Financial Services operating account at Home Trust Bank. He stated that these check transactions should have been a red flag to the Bank and MSSB if “they had thought about it for a minute.”

23. Mr. Bailey testified that he and Southern Financial had five separate business accounts at Home Trust. In addition to the Southern Financial account that theoretically held investors dollars, there was an operating account for Southern Financial to pay its expenses, there was a “1031 Exchange Services,” account (that was supposed to be for 1031 exchanges administered by Southern Financial for investors including some of the defendants), an “AVL Properties LLC” (a real estate investment company operated only by Bailey for his own benefit) and an “Uptime Computer Sales and Service LLC” account (another Bailey operated company for his own benefit). 1

24. Mr. Bailey stated that numerous checks for large sums of money were written by himself and his representatives to transfer money out of the MSSB and Home Trust investor accounts and into the Southern Financial operating account and to the other Bailey entitites. The money transferred to the Southern Financial operating account went to pay expenses such as rent and telephone. Bailey confessed that “the investors' money was going to pay things that their money should not have been going to pay.”

25. The amounts of the individual checks transferring money from Home Trust and/or MSSB to the Bailey entities like AVL Properties and Uptime Computer were very large sums of money, including, Bailey believes, $75,000 and $100,000. Bailey stated that, for example, the amount of money that was taken from the MSSB investment account and transferred via checks to AVL Properties alone was in the range of $1 million to $2 million over a six-year period. For Uptime Computer Sales and

Service, he believes that the amounts of the checks written would have ranged from $30,000 to $50,000 each and totaled more than $500,000 over time.

26. Bailey testified that he transferred large sums of money (hundreds of thousands of dollars at a time) back and forth between the MSSB account and the Home Trust 1031 Exchange Services account. He also stated that he transferred large sums from the 1031 Exchange account at Home Trust to other Bailey entity accounts.

27. Bailey also described how he paid himself directly with checks written to himself from the MSSB brokerage account and from the Home Trust investor account. These individual checks to himself sometimes totaled as much as $75,000 to $100,000.

28. Mr. Bailey said that if anyone at Home Trust Bank had had an overview of the activities in Southern Financial accounts (which they, of course, did), there “would have been some huge red flags that would have been raised” by all of the transactions back and forth between the accounts. Similarly Bailey's check writing activities at MSSB were staggering. In 2010, Bailey and his representatives wrote checks in the amount of $338,990,000 on the MSSB accounts.

29. Mr. Bailey stated that at least five employees of MSSB asked him questions about the fact that they did not understand how he was doing business, how money was flowing in and out of the accounts, and how his business worked. These employees included three branch managers and two operations managers, and their questioning of him spanned several years.

30. Mr. Bailey also stated that his suspicious activities apparently generated questions from New York, where Citibank, the parent company of MSSB is located. On information and belief, the activities in the Southern Financial accounts at MSSB did trigger SAR reports, which MSSB was grossly negligent in not following through sufficiently to understand what was going in the accounts. In fact, an article in the Wall Street Journal on April 12, 2012 details four years of Securities and Exchange Commission regulatory sanctions against MSSB for failing to properly monitor banking transactions and suspicious activity reports for potential criminal activity, as required by the Bank Secrecy Act.

31. Mr. Bailey further stated that he has a personal account at MSSB and that MSSB knew that these accounts in question were different from his personal account. He further stated that “there was a knowledge and a conversation with virtually all of these [MSSB] people” that the MSSB investment account “was used to hold money that belonged to other people.”

2. Bank and Broker-Dealers' Regulatory Requirements

32. Mr. Bailey and Southern Financial opened and maintained several accounts at Home Trust Bank and Smith Barney into which the investment funds of plaintiffs and other victims of Mr. Bailey's fraud were deposited.

33. Banks and broker-dealers in securities are subject to the Bank Secrecy Act, certain provisions of the USA PATRIOT Act, and the U.S. criminal statutes applicable to money laundering. Implementing regulations of the Bank Secrecy Act are promulgated and enforced by the Department of the Treasury's Financial Crimes Enforcement Network (“FinCEN”) often in collaboration with the Federal Functional Regulators. These regulations impose a range of anti-money laundering compliance requirements on the regulated institutions in the United States. Supervision and enforcement for these compliance efforts are undertaken by FinCEN and the functional regulators.

34. Banks and broker-dealers in securities are required to have implemented Customer Information Programs to adequately obtain and verify the identity of persons or entities that are opening accounts with them or establishing other on-going business relationships. Banks and broker-dealers in securities must design their programs to enable them to establish a “reasonable belief” that they know the true identity of the customer. Also, the bank or broker-dealer in securities must establish policies and procedures for Customer Due Diligence (“ODD”) and Enhanced Due Diligence (“EDO”) that is commensurate for the level of money laundering risk or terrorist financing risk posed by a particular customer or category of customers.

35. Banks and broker-dealers are required to implement policies and procedures to meet the record-keeping requirements of the Bank Secrecy Act (e.g., the reporting of large currency transactions into or out of an account or the purchase of monetary instruments for $3,000 or more). In addition to recording the information, these financial institutions must retain this documentation for a period of five years, and must determine, based on their risks posed by their customer base and the services provided, what type of ongoing monitoring should be implemented in order to detect and report unusual or suspicious activity.

36. Broker-dealers in securities and mutual funds are required by regulations issued by FinCEN and their primary functional regulator to file suspicious activity reports (“SARs”) when transactions involve or aggregate to at least $5,000 and are (1) known or suspected criminal violations where the broker-dealer or mutual fond is either an actual or potential victim of a criminal violation, or the broker-dealer or mutual fond is used to facilitate a criminal transaction, or (2) are transactions that (a) involve funds derived from illegal activity intended or conducted to hide or disguise fonds derived from such illegal activity.... or (c) appear to serve no business or apparent lawful purposes, and for which the broker-dealer or mutual fond know no reasonable explanation after examining the available facts relating to the transaction and the parties.

37. FinCEN also has promulgated numerous bulletins and notifications to the financial services industry to beware, and to be especially prudent in, dealings involving elderly customers. Financial abuse of the elderly is a significant concern causing FinCEN repeatedly to admonish banks and brokerages to be carefol to “know their customer” when transactions involve elderly clients. The reason for this regulatory focus is that elderly persons are particularly vulnerable to financial abuse and financial crimes. Therefore, banks and brokers are responsible for heightened vigilance when handling their money. Many of the Plaintiffs in this I case are elderly and many have lost their entire life savings due to the events outlined herein.

38. Suspicious activity reporting rules for banks are similar and require that any transaction conducted or attempted by, at or through the bank involving or aggregating $5,000 or more in funds or other assets that the bank knows, suspects or has a reason to suspect (a) involves funds derived from illegal activities or is intended or conducted in order to hide or disguise funds or assets derived from illegal activities (including without limitation, the ownership, nature, source, location, or control of such funds or assets) as part of a plan to violate or evade any law or regulation or to avoid any money laundering regulation; (b) is designed to evade a money laundering regulation, for example, a cash reporting regulation; or (c) has no business or apparent lawful purposes or is not the sort in which a particular customer would normally be expected to engage and the bank knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction, must be reported.

39. The Federal Financial Institutions Examination Council has provided a list of “red flags ' for banks to help them determine whether a SAR is required. These indicators point to situations in which the bank should perform additional due diligence to determine whether the bank should file a SAR.

40. These indicators include the following, which upon information and belief occurred in this case:

· A customer who conducts a number of transactions, which individually do not meet reporting requirements, such as for currency transactions, but taken together, do reach such levels.

· Numerous transactions are conducted in even dollar amounts.

· Transactions not consistent with the customer's known business or income level.

· A customer maintains multiple accounts at a bank for no apparent legitimate reason. Inter-account transfers are evidence of common control.

· Accounts with a high volume of activity, which carry low balances or are frequently overdrawn, may be indicative of money laundering.

· A customer repeatedly buys a number of official bank checks with no apparent legitimate reason.

· Frequent wire transfers that are not justified given the nature of the business of the customer.

· The customer has a high volume of incoming and outgoing wire transfers but maintains low or overdrawn account balances.

· There is a pattern of wire transfers of similar amounts both in and out of the customer's account on the same day or the next day.

41. All banks and broker-dealers are required to establish and maintain procedures and systems to enable them to comply with the FinCEN Laws and the guidances provided by regulatory agencies. These systems require a group of people and automated computer monitoring. Computerized systems also include detection protocols for finding overdrafts, payments against uncollected funds, check kiting and potential Ponzi schemes, among other things, to enable users to protect themselves against fraud, and to guard against money laundering and other crimes.

42. Throughout the years relevant to this case, Defendants failed egregiously, and on an ongoing basis, to comply with these obligations set forth above.

3. Defendants' Relationship with Mr. Bailey and Southern Financial

43. Defendants knew from the outset of their relationship with Mr. Bailey and Southern Financial that as part of their business, Mr. Bailey and Southern Financial received funds from investors to be held as the property of those investors and distributed in furtherance of their investment purposes and objectives.

44. Mr. Bailey and Southern Financial collectively were significant and active customers of Defendants in Asheville, North Carolina. He frequently deposited and withdrew large sums of money. Mr. Bailey went to Defendants' offices in Asheville, North Carolina, regularly, depositing large numbers of checks, purchasing cashier's checks, withdrawing funds, and transferring money from one account to another.

45. Each Defendant opened at least two accounts for Southern Financial, and funds belonging to Plaintiffs and other investors were deposited into those accounts. Defendants knew that the funds deposited in such accounts came from Plaintiffs and/or other customers of Mr. Bailey and Southern Financial, and that the funds did not belong to Mr. Bailey or Southern Financial, but were held in trust to be used solely for the benefit of the investors who were customers of Mr. Bailey and Southern Financial, including Plaintiffs.

46. The transactions in the accounts of Mr. Bailey and Southern Financial with Defendants triggered numerous red flags. The red flags in turn triggered a duty on the part of Defendants to investigate and determine whether it had further duties, including the requirement that it file a SAR. The red flags included the following:

· Deposits of investor funds into the accounts of Mr. Bailey and Southern Financial were commingled with other investor funds and the funds of Mr. Bailey and Southern Financial. Mr. Bailey and Southern Financial engaged in transactions with the funds that demonstrated that Mr. Bailey and Southern Financial were treating the investors' funds as if they were their own funds.

· Funds in the accounts of Mr. Bailey and Southern Financial that Defendants knew knowingly disregarded that the funds received from Plaintiff investors were regularly used for the personal benefit of Mr. Bailey. It is not customary, normal, or acceptable for persons such as Mr. Bailey to pay personal and business expenses from investor funds, and Defendants knew that.

· Upon information and belief, Mr. Bailey and Southern Financial had recurring urgent withdraws of investor funds from their accounts. In correction with those withdrawals, they demanded access to the deposited funds before the funds would be available

© 2016 Thomson Reuters. No claim to original U.S. Government Works. 7 Leslie A. WHITTINGTON, Terry R. Sloan, Linnea J...., 2013 WL 10945133... in the usual and regular time after deposits of investor funds were made. The urgency of those needed withdrawals, by purchases of cashier's checks and otherwise, was communicated through demands by or on behalf of Mr. Bailey and Southern Financial that Defendants make investors' funds available for withdrawal for the benefit of Bailey and Southern Financial before the deposited funds would normally be available, and Defendants complied with their requests not to put “holds” on such deposits.

47. On multiple occasions in the period prior to December 2010, Mr, Bailey and Southern Financial withdrew substantial sums from the Southern Financial accounts in the form of checks or cash in amounts, which should have triggered the requirement for Currency Transaction Reports, and should have been brought to the attention of responsible employees, officers and executives at Defendants' offices.

48. Upon information and belief, Mr. Bailey, personally or through his agents, regularly transferred money from one bank account to another as between the Defendants. These transfers took place by ACH, wire transfer, check, counter check, and telephone transfer. Many of these transfers took place to make up for overdrafts in the accounts. Such transfers, and the overdrafts that necessitated them, were not consistent with a legitimate business enterprise.

49. Mr. Bailey regularly used money received from investors and deposited in Defendants' accounts to pay business and operating expenses and for personal purposes. Defendants knew that such conduct was improper,

50. Defendants knew that Mr. Bailey was using cashier's checks and other transfers to withdraw substantial amounts of money from investor funds for his personal benefit.

51. Defendants knew that Mr. Bailey was conducting a large number of transactions in even dollar amounts. Many of those transactions were for his personal benefit or for the personal benefit of his own affiliated companies.

52. Defendants knew that there was an unreasonably high volume of transfers and cashier's checks, in connection with sometimes over-drawn accounts.

53. Defendants knew that there was a pattern of deposits of investor funds transfers followed by withdrawals or disbursements very shortly thereafter for purposes that were inconsistent with the proper use or investment of investor funds. Money entrusted by Plaintiffs to Mr. Bailey and Southern Financial was deposited into these accounts and then unlawfully converted to the personal use of Mr. Bailey and Southern Financial in the course of their extensive criminal enterprise. Plaintiffs bring this action to recover the losses they have suffered as a result of the wrongdoing of Defendants.

54. Defendants, including their employees, officers and executives, continually ignored internal warnings about the swindle, thereby allowing the Ponzi scheme to continue unabated for years.

D. LEGAL CLAIMS

COUNT ONE—NEGLIGENCE AND RECKLESSNESS

55. Plaintiffs incorporate herein paragraphs 1-53 above.

56. Defendants had a duty to monitor the accounts of Mr. Bailey and Southern Financial, including the accounts in which Plaintiffs' assets were deposited at Defendants' institutions, in accordance with the legal obligations set forth above and pursuant to the common law of North Carolina.

57. In violation of their duty of reasonable care, these Defendants failed to comply with laws and customary banking practices, failed to detect and report the unlawful conduct of Mr. Bailey and Southern Financial, and allowed Mr. Bailey and Southern Financial to mishandle Plaintiffs' assets, use those assets in inappropriate ways, and transfer them to entities that had no right to

© 2016 Thomson Reuters. No claim to original U.S. Government Works. 8 Leslie A. WHITTINGTON, Terry R. Sloan, Linnea J...., 2013 WL 10945133... them. This willful blindness prevented the expedient discovery of Mr. Bailey's unlawful conduct which would have prevented or greatly lessened Plaintiffs' losses. Plaintiffs were damaged as a proximate result of Defendants' negligence. Their damages include the loss ' of the funds that they invested with Mr. Bailey and Southern Financial and the return on j investments that they should have earned if the funds had been properly invested.

58. Defendants also negligently failed properly to investigate and monitor the banking' activities of Mr. Bailey and knew or should have known he was kiting checks and converting funds to his own use.

59. Plaintiffs are entitled to recover actual damages from Defendants as compensation for all Plaintiffs' losses, plus interest.

60. In addition, because Defendants with acted with recklessness and in willful and/or conscious disregard of the statutory and common law obligations and the rights of others, Plaintiffs also request an award of punitive damages.

COUNT TWO-NEGLIGENCE IN UNDERTAKING A SPECIAL DUTY

61. Plaintiffs incorporate herein paragraphs 1-59.

62. Defendants undertook duties owed by banks and brokerage houses to “know their customers” by monitoring transactions with computer systems and manpower designed to flag suspicious activities, generate reports and question suspicious activities of customers. Representatives of Defendant Smith Barney's offices in Asheville, NC and New York, NY questioned Mr. Bailey on multiple occasions about his activities which they viewed as suspicious. Upon information and belief, these activities caused Defendants' computer systems to generate written reports designed to alert them to the suspicious, potentially criminal activities of Mr. Bailey taking place via the Southern Financial Services accounts therein. It was foreseeable that these activities would, and did, cause significant harm to Defendants' investors and depositors, including Plaintiffs. Defendants failed to take effective action even as they suspected and/or should have suspected that Mr. Bailey and Southern Financial were perpetuating a fraud.

63. Defendants knew or should have known they were providing these services for the ultimate protection of the individuals whose money was deposited into Defendants accounts and removed from those accounts by Mr. Bailey through the course of many criminal and fraudulent transactions over several years. Defendants monitored these transactions for the ultimate protection of innocent third parties, including Plaintiffs. Defendants repeatedly allowed suspicious transactions for high-dollar amounts to occur in the Southern Financial accounts and ignored reports that indicated that fraud was highly likely.

64. In conducting these monitoring, reporting and surveillance activities and Defendant Morgan Stanley's questioning Mr. Bailey about the suspicious activities to which this surveillance alerted them, Defendants undertook a special duty. Defendants failed to exercise reasonable care in conducting these surveillance, reporting and monitoring actions that were designed to discover criminal activity. In so acting, Defendants breached their special responsibility and duty to Plaintiffs by foiling to exercise reasonable care to protect their undertaking, as described above.

65. Plaintiffs unwittingly but justifiably relied upon the thoroughness of Defendants' processes and dissemination of the results, which, upon information and belief, were published to employees in Asheville, North Carolina and New York, New York, as well as to Mr. Bailey, via employees' questioning Mr. Bailey on multiple occasions about the appearance of impropriety his actions created.

66. In failing to fully and adequately monitor, report and question Mr. Bailey for his suspicious activities, in failing to notify Plaintiffs or law enforcement of the reports Defendants did generate, in suppressing further relevant inquiry and knowledge about the danger of his activities, and in collaborating between its various offices to understate the dangers posed by Mr. Bailey's banking activities, all for pecuniary profit and gain, Defendants acted recklessly, wantonly and in calculated disregard for the welfare of the people, including Plaintiffs, whose monies were tunneled in and out of these accounts by Mr. Bailey and Southern Financial.

67. As a direct and proximate result of Defendants' failure adequately to conduct their investigation of Mr. Bailey and his Southern Financial accounts, accurately to publish reports of his questionable activities, to notice “red flags”, and/or to disseminate accurate and truthful information about the potential dangers posed by Mr. Bailey's suspicious transactions, after undertaking to do so; (1) the risk of harm to Plaintiffs from Mr. Bailey's Ponzi scheme was increased; and (2) the Plaintiffs lost substantial sums of their money, as a result of which the Plaintiffs have suffered a dramatic reduction of their financial well-being, incurred great emotional pain and suffering, and their enjoyment of life has been greatly impaired, which damages are continuing in nature.

68. Plaintiffs have incurred monetary damages as a result of Defendants' negligent conduct. Many have lost their entire life's savings.

69. Plaintiffs are entitled to actual and punitive damages as a result of Defendants' negligence and recklessness in breaching their undertaking of a special duty, which has caused great harm to Plaintiffs.

COUNT THREE - NEGLIGENT AND RECKLESS SUPERVISION

70. Plaintiffs incorporate herein paragraphs 1-68 above.

71. Mr. Bailey defrauded Plaintiffs and converted the assets of Plaintiffs.

72. Plaintiffs were damaged by Mr. Bailey's misconduct.

73. Defendants had a duty to supervise the conduct and activities of their representatives who worked with Mr. Bailey.

74. Defendants were negligent and reckless in their supervision of these representatives. Defendants failed properly to review, monitor and supervise Mr. Bailey's accounts and his transactions with client assets.

75. With even a minimal level of appropriate supervision of Defendants' representatives and of Mr. Bailey's accounts, Defendants would have discovered long ago that Mr. Bailey was commingling the assets of his clients in accounts in his own name and misappropriating client assets for his own purposes. It is clear that Defendants provided no meaningful supervision of their representatives who dealt with Mr. Bailey or supervision of Mr. Bailey's activities.

76. Had Defendants properly supervised their representatives and Mr. Bailey's accounts, they would easily have uncovered facts that made it highly foreseeable that Mr. Bailey was going to continue to defraud clients.

77. Defendants' negligence was a proximate cause of the losses sustained by the Plaintiffs.

78. Plaintiffs are therefore entitled to judgment against Defendants in the amount of all of Plaintiffs' losses, plus prejudgment and postjudgment interest.

79. Because Defendants' conduct rose to the level of a conscious disregard of the rights of Plaintiffs, Plaintiffs are entitled to recover punitive damages in an amount to be determined by the jury.

COUNT FOUR - UNJUST ENRICHMENT

80. Plaintiffs incorporate herein paragraphs 1-78.

81. Defendants received a substantial amount of fees as a result of their negligent and improper business relationship with Mr. Bailey and Southern Financial. Defendants were unjustly enriched in this regard.

82. Defendants should be ordered to return to Plaintiffs as damages all or a fair portion of the fees and commissions with which Defendants were unjustly enriched,

COUNT FIVE-NORTH CAROLINA CONSUMER PROTECTION ACT VIOLATION

83. Plaintiffs incorporate herein paragraphs 1-81.

84. Defendants engage in trade, commerce, and/or consumer transactions, as defined in N.C. Chapter 75.

85. While holding themselves out to the public, including Plaintiffs, as responsible and competent financial institutions that served the best interests of the owners of deposited funds and fulfilled their legal duties, Defendants engaged in unfair and/ or deceptive acts and practices affecting the conduct of trade and commerce in violation of N.C. Chapter 75 in connection with Defendant's dealings with Mr. Bailey and Southern Financial and their clients, including Plaintiffs. As set forth above, Defendants profited from the provision of banking services to a Ponzi scheme fraudster while willfully and/or recklessly, or, in the alternative, negligently, ignoring their own legal obligations. This negligence resulted in a multi-year series of suspicious and inappropriate transactions and conduct by Mr. Bailey and Southern Financial, which conduct created a significant and foreseeable risk of substantial injury to consumers and was therefore unfair within the meaning of the North Carolina Consumer Protection Act.

86. Plaintiffs were damaged as a result of Defendants' unfair or deceptive trade practices.

87. Plaintiffs are entitled to recover from these Defendants their actual damages, treble damages, pre-judgment interest, and attorney's fees pursuant to Chapter 75, §§ 75-1.1 et seq.

COUNT SIX-CONVERSION

88. Plaintiffs incorporate herein paragraphs 1-86.

89. Southern Financial customers have the possessory right and interest to the millions of dollars they personally invested with Southern Financial.

90. Upon information and belief, all of the money invested with Southern Financial was commingled in the Defendants' depository accounts. Defendants were responsible for servicing and maintaining these accounts.

91. By virtue of servicing and maintaining these two accounts, Defendants were required to monitor the banking and brokerage activities of Southern Financial. It was this obligation that led Defendants to uncover a number of red flags indicating that Bailey was engaging in fraud between 2008 to 2010, if not earlier.

92. Largely ignoring a number of these red flags, Defendants continued to provide Mr. Bailey with banking and brokerage services and watched as additional monies from unknowing customers flowed into the Southern Financial accounts, further perpetuating Bailey's Ponzi scheme.

93. Upon learning of suspicious activities indicating fraud, Defendants intentionally exercised dominion and control over Southern Financial customer's money in a manner inconsistent with and in willful disregard of their interests by failing to discontinue banking and brokerage services to Mr. Bailey and Southern Financial. This failure by Defendants allowed Southern

Financial and Mr. Bailey to continue to lure unsuspecting customers, with the additional money flowing into the Defendants accounts resulting in fees and profits to Defendants.

94. Defendants' failure to discontinue banking and brokerage services has resulted in the wrongful conversion of Southern Financial specifically identifiable funds belonging to Plaintiffs herein. Defendants are therefore liable to Plaintiffs as Southern Financial customers for having wrongfully converted these monies and are now obligated to return all such monies.

THEREFORE, Plaintiffs respectfully request that the Court grant them the following relief:

95. Award judgment in favor of each Plaintiff and against Defendants for all losses incurred by Plaintiffs as a result of the misconduct set forth above.

96. Order Defendants to return to Plaintiffs all or a fair portion of the banking and investment fees with which Defendants were unjustly enriched.

97. Award prejudgment interest and attorneys' fees in favor of each Plaintiff.

98. Award treble or punitive damages in favor of each Plaintiff and against Defendants.

99. Afford Plaintiffs a trial by jury.

100. Provide such other relief as the Court deems to be just and proper.

DATED at Asheville, North Carolina,

This the 19th day of June, 2013.

Respectfully submitted,

John B. Veach III, N.C. Bar No. 26385

H. Naill Falls Jr.

Johanna S. Fowler, N.C. Bar No. 24679

FALLS & VEACH

20 CedarclifFRoad

Asheville, North Carolina 28803

Telephone: (828) 277-6001

Facsimile: (828) 277-6088 [email protected]

Footnotes 1 Under Section 1031 of the United States Internal Revenue Code (26 U.S.C. § 1030. the exchange of certain types of property may defer the recognition of capital gains or losses due upon sale, and hence defer any capital gains taxes otherwise due. Bailey's company purported to (and in some cases actually did) facilitate 1031 exchanges for his clients.