(CN) - Investors cannot hold Bear Stearns accountable for clearing fraudulent trades worth millions by now defunct broker A.R. Baron & Co., the 2nd Circuit ruled Friday.
Before JP Morgan Chase swallowed the firm after its collapse in 2008, Bear Stearns spent four years as the clearing broker for A.R. Baron & Co.
Baron's former officers, directors and key employees now stand convicted of various crimes for their roles in a massive securities fraud that fleeced customers for millions before the broker-dealer's 1996 bankruptcy after a four-year run.
In 2008, a federal judge dismissed the attempt by customers who lost more than $7.25 million to recover from Bear Stearns and others that had allegedly "propped the company up during its brief but felonious life."
The 2nd Circuit affirmed dismissal of the case last year and refused Friday to grant the investors a rehearing, despite a Securities and Exchange Commission amicus brief supporting their position.
"Appellants allege that Bear Stearns was aware of the manipulations, knew that these manipulations were leading to a crisis, but continued to clear trades that did not involve unnecessary exposure to itself," Judge Ralph Winter wrote for a three-judge panel. "Knowledge alone, however, is not enough to attach liability to a clearing broker."
Even if the investors could prove their allegations, they have not claimed that Bear Stearns directed or participated in Baron's fraud, the Manhattan-based federal appeals court emphasized
"There is a real danger of harm to the financial industry in allowing such allegations to suffice to subject clearing brokers to the cost of discovery and perhaps a trial even though there is no evidence of participation by the brokers in the fraud or manipulation," Winter wrote.
Subjecting brokers to such liability would drive up the costs of trading, and inhibit normal business activity, the court said.
"Although claiming that defendants are liable for all losses of all investors caused by Baron, whether or not the losses involved sham transactions by a particular defendant, appellants have never offered either a theory of vicarious liability under state law or of controlling person liability under federal law," the opinion concludes. "The SEC's amicus brief fails even to purport to fill this gap."
Read the Top 8
Sign up for the Top 8, a roundup of the day's top stories delivered directly to your inbox Monday through Friday.