Can Your Law Firm Be Held Liable For A Pyramid Scheme Conducted By One Of The Partners?

A recent judgment handed down by the Kwazulu-Natal division of the high court has found one of Durban’s most prestigious and oldest law firms liable for a ponzi scheme that was conducted by one of its senior attorneys under the firm’s auspices. In Stols v Garlicke and Bousfield, PKF Durban Inc (and others as third parties) [2020] 4 All SA 850 (KZP), a senior consultant (Cowan) at the law firm Garlicke & Bousfield (Garlicke) offered a “bridging finance” service to the firm’s clients. This involved providing short-term finance at high interest rates to firm clients who were acquiring immovable property and needed to put up a deposit or funds in a very short period of time, but were unable to access such funds on a short-term basis.

One Merlin Stuart Stols (Stols) heard about the bridging finance offered at Garlicke, and approached Cowan to find out if he could participate as an investor. The parties went back and forth on the details and eventually Stols agreed to invest in the scheme. The pleaded terms of the contract between Garlicke and Stols were, inter alia, that Stols would deposit the sum of R7 million with Garlicke in two installments. The first installment would take the form of a payment of R5 million into the bank account of a third party company called Topspec Investments (Pty) Ltd on Garlicke’s behalf on 5 October 2010. The second installment would take the form of a payment of R2 million into Garlicke’s trust account on 13 October 2010. Garlicke would return the amount of R7 million to Stols by no later than 30 November 2010, together with interest thereon at the rate of 30% per annum, from 13 October 2010 to date of payment and, 30% per annum on R5 million, from 5 October 2010 to 12 October 2010. When these amounts were not repaid by Garlicke, Stols instituted action against the firm.

In its plea, Garlicke admitted that Cowan was an executive consultant and practising attorney at Garlicke, and Stols had caused an amount of R2 million to be paid into its trust account on 13 October 2010. However, the law firm denied that Cowan was authorised to conclude any such contract on its behalf, and alleged that Cowan had entered into such contract for his own dishonest and illegal purposes.

In coming to the conclusion that Garlicke should be held liable for the amounts invested with it by Stols, Mnguni J placed reliance on several factors:

1. Cowan operated his bridging finance scheme from Garlicke’s offices.
2. Garlicke allowed Cowan to use the firm’s trust account for payments in connection with the scheme and to earn commission for the benefit of Garlicke in relation to the bridging finance transactions.
3. Some directors of the firm were aware of the bridging finance scheme even though they may not have been aware of how it worked.
4. The letters of undertaking that Cowan provided to investors guaranteeing repayment of their investments on specified maturity dates were provided on Garlicke’s letterhead.

The court concluded that Garlicke had provided ostensible authority to Cowan to conduct the scheme. Stols had relied on the representations made by Cowan to his detriment, and he was entitled to redress for that reliance.

Closing Thoughts

Various third parties (insurers, auditors, etc) were cited in the proceedings in the Stols case, and it is likely that Garlicke would have been able to divert at least some of its liability onto these third parties. With that said, there are various other repercussions that a firm needs to consider in a situation like this one:

1. The reputational harm that arises when a law firm is found to have entertained a ponzi scheme by one of its attorneys.
2. The possibility of joint and several liability of the partners or directors of the firm for the losses suffered by innocent clients (see Section 34(7) of the Legal Practice Act).
3. The risk to clients arising from a lack of minimum operating standards relating to the use of the firm’s trust account.
4. The damage to the internal fabric of the firm (in the form of loss of trust) because partners don’t know what their colleagues are getting up to, and there are no procedures to find out.

If the partners in the Stols case had regularly reviewed the firm’s trust accounts, it is likely that they would have been alerted to Cowan’s ponzi scheme. According to the Financial Intelligence Centre, transactions that ought to arouse a partner’s suspicions include the following:

• – Deposits of funds with an immediate transfer elsewhere;
• – Unwarranted and unexplained international transfers;
• – Large fee payments that cannot be reconciled with an appropriate invoice;
• – Large interest payments into or out of the trust account that are not consistent with market rates;
• – Transaction amounts that are inconsistent with the purpose of the transaction (e.g. a deposit of R50 million for the purchase of a house).

While there is no foolproof method to detect suspicious transactions in a trust account, maintaining a constant and watchful eye on the bank statements and raising queries when one’s suspicions are triggered is strongly recommended in order to prevent the malfeasance that the Garlicke partners encountered.

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Ivor Heyman is an advocate at the Johannesburg Bar. He publishes articles of interest to attorneys and their clients. For questions or comments you can reach him at adv.heyman@gmail.com or 061-120-8740.