Opinion
99 Civ. 11395 (RWS).
November 29, 2000.
Plaintiff SECURITIES AND EXCHANGE COMMISSION, THOMAS M. MELTON, ESQ. Salt Lake City, UT. ROBERT BLACKBURN, ESQ. New York, NY.
Attorney for Defendant R.J. Blech, PROSKAUER ROSE Attorney, Los Angeles, CA By: RICHARD MARMARO, ESQ. Of Counsel.
Attorney for Defendant T. Rittweger, MILBANK, TWEED, HADLEY McCLOY New York, N.Y. By: ANDREW E. TOMBACK, ESQ. Of Counsel.
Attorney for D. Brandon Defendant, GETTY, KEYSER MAYO Lexington, KY 40507 By: RICHARD A. GETTY, ESQ. Of Counsel.
Attorney for Third-Party Defendants, PATTISON FLANNERY New York, N.Y. By: THOMAS P. PATTISON, ESQ. Of Counsel.
Attorneys for Plaintiff-Intervenors: HONORABLE MARY JO WHITE United States Attorney for the Southern District of New York Attorney for Intervenor United States of America, New York, N.Y. By: TIMOTHY J. COLEMAN, Assistant US Attorney Of Counsel.
Attorney for Customer-Intervenor SECO New York, N.Y. By: WILLIAM A. MAHER, ESQ. FREDERICK P. KESSLER, ESQ. Of Counsel.
Attorney for Customer-Intervenor SECO Tulsa, OK By: DONALD L. KAHL, ESQ. T. LANE WILSON, ESQ. Of Counsel.
Attorney for Customer-Intervenors S. Cole-Hatchard, et al New York, N.Y. By: ARMAND P. MELE, ESQ. Of Counsel.
Attorney for Intervenor Ameritrade Washington, DC By: RICHARD J. MORVILLO, ESQ. Of Counsel.
Attorney for Receiver New York, N.Y. By: CARL H. LOEWENSON, ESQ. Receiver and Fiscal Agent.
Attorney for Receiver New York, N.Y. By: RANDY PAAR, ESQ. Of Counsel.
A little over a year ago, on November 17, 1999, this action was initiated by the plaintiff, the Securities and Exchange Commission (the "SEC"), to freeze the assets of Credit Bancorp, Ltd. and its related entities (collectively, "Credit Bancorp") upon the allegations that Richard Jonathan Blech ("Blech") and others had engaged in a complicated securities fraud. The fraud, which was in effect a Ponzi scheme, affected over 200 customers with interests exceeding $200 million. An equity receivership was established on January 21, 2000. Carl H. Loewenson, Jr. ("Loewenson"), the court-appointed receiver in this action (the "Receiver"), has now marshaled assets and has proposed an interim distribution plan, as have others including the SEC.
The essence of this proceeding is to seek redress to the extent possible for the fraudulent conduct of the defendants as quickly and as equitably as can be done. Life savings and substantial interests are at stake. The complications of the task are evident from what follows as is, hopefully, the equity sought to be achieved at this appropriate season.
The SEC has moved for partial distribution of the receivership estate pursuant to Section 27 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78aa. As mentioned above, interim distribution plans have been proposed by the Receiver, the SEC. and certain others, namely, intervenors SECO and Dr. Gene Ray ("Ray"), (collectively, the "SECO Intervenors"), and intervenors Thomas Stappas, et al. (the "Stappas Intervenors"). These plans are referred to as, respectively, the Compromise Plan, the SEC Plan, the SECO Plan, and the Stappas Plan. Comments regarding each of the proposed plans have been submitted by the Credit Bancorp customers, including but not limited to those customers who have intervened in this action. In addition, the SECO Intervenors have moved jointly for partial summary judgment on certain claims for relief raised in their complaints in this action. Finally, Deutsche Bank Securities, Inc. and DB Alex, Brown LLC (collectively, "Deutsche Bank") have moved to intervene in this action.
This motion was initially joined in by Centigram Communications Corporation ("Centigram"). Centigram's claims against Credit Bancorp have been dismissed with prejudice, see Judgment, dated June 22, 2000, rendering its motion for partial summary judgment moot. In addition, although the SECO Intervenors are the only parties to have made a formal motion for recovery of their securities, some of the other customers have made similar claims pursuant to comments regarding the proposed plans for partial distribution. See. e.g., Letter from Karla G. Sanchez, Patterson, Belknap, Webb Tyler on behalf of Compositech, Ltd. ("Compositech") of June 28, 2000 (adopting SECO Intervenors' arguments in support of claim that Compositech should be entitled to trace the shares it deposited with Credit Bancorp); Letter from James Wesley Kinnear on behalf of John Dillon ("Dillon") to the Court of July 14, 2000 (same).
To effectuate any plan the interests of Intervenor Stephenson Equity Company ("SECO"), the customer with the largest interests, and others similarly situated, must be adjudicated. The Compromise Plan is approved and hereby made effective, and the interests of SECO and others in its situation are subject to that plan, based upon the resolution of the pending motions as described below.
Parties
The parties in this action are set forth in prior opinions of this Court, familiarity with which is presumed. See SEC v. Credit Bancorp, Ltd., 194 F.R.D. 457 (S.D.N.Y. 2000) ["Credit Bancorp I"] (describing initiation of this action by the SEC against the Credit Bancorp corporate and individual defendants, and granting motions by certain customers to intervene); SEC v. Credit Bancorp, Ltd., 103 F. Supp.2d 223, 224 (S.D.N.Y. 2000) ["Credit Bancorp IV"] (denying reconsideration of decision granting customer intervention and noting grant of intervention to additional customer by separate order of April 5, 2000); Memo. Opinion of July 25, 2000 (granting intervention to broker-dealer Ameritrade, Inc.); SEC v. Credit Bancorp. Ltd., No. 99 Civ. 11395, 2000 WL 1170136 (S.D.N.Y. Aug. 16, 2000) ["Credit Bancorp VIII"] (granting intervention to additional customer).
Prior Proceedings
The proceedings in this action which preceded the filing of the instant motions are set forth in the prior opinions of this Court, familiarity with which is presumed. See Credit Bancorp I, 194 F.R.D. 457; SEC v. Credit Bancorp, Ltd., 93 F. Supp.2d 475 (S.D.N.Y. 2000) ["Credit Bancorp II"]; SEC v. Credit Bancorp, Ltd., 96 F. Supp.2d 357 (S.D.N.Y. 2000) ["Credit Bancorp III"]; Credit Bancorp IV, 103 F. Supp.2d 223; SEC v. Credit Bancorp. Ltd., 109 F. Supp.2d 142 (S.D.N.Y. 2000) ["Credit Bancorp V"]; SEC v. Credit Bancorp, Ltd., No. 99 Civ. 11395, 2000 WL 968010 (S.D.N.Y. July 12, 2000) ["Credit Bancorp VI"]; SEC v. Credit Bancorp, Ltd., 194 F.R.D. 469 (S.D.N.Y. 2000) ["Credit Bancorp VII"]; Credit Bancorp VIII, 2000 WL 1170136.
The proceedings relevant to the instant motions are set forth herein.
By complaint filed on November 17, 1999, the SEC initiated the instant enforcement action against defendants Credit Bancorp, Blech, Douglas C. Brandon ("Brandon"), and Thomas Michael Rittweger ("Rittweger") (collectively, the "Defendants"). Also on November 17, 1999, this Court granted an ex parte motion by the SEC for a temporary restraining order and asset freeze (the "TRO") to prevent the defendants from, inter alia, dissipating assets and continuing to accept and deposit funds from potential investors. On November 23, 1999, after several extensions of the TRO and asset freeze, and after hearing argument from the representatives of various parties, the Court issued an order (the "November 23 Order") altering the terms of the November 17 Order. The November 23 Order inter alia continued the freeze of the Defendants' assets and appointed Loewenson as "Fiscal Agent" of Credit Bancorp, Blech, and Rittweger.
As was noted in Credit Bancorp I, the intervenors generally may prefer the term "customer" to the term "investor" due to concerns about their ultimate entitlement to a distribution should Credit Bancorp be liquidated and the remaining assets distributed according to a plan of priority. See Credit Bancorp I, 194 F.R.D. at 461 n. 4. SECO also prefers the term customers, apparently because it seeks to characterize its relationship with Credit Bancorp as involving a means for obtaining credit rather than an investment. See SECO Memo. Supp. Partial Summ. J. at 9. This Court has previously used these terms interchangeably and will continue to do so herein because the semantic difference does not affect the outcome of the instant motions.
On January 21, 2000. the Court granted a renewed request by the SEC for appointment of a receiver of Credit Bancorp (the "January 21 Order"), transforming Loewenson from a Fiscal Agent with limited review and investigatory powers into a receiver with both the powers and the responsibility to ensure the protection and orderly marshaling of Credit Bancorp's assets.
On January 19, 2000, January 24, 2000, January 26, 2000, and January 31, 2000, various Credit Bancorp customers (the "Intervenors") moved for leave to intervene in this action. Those motions were granted in the opinion of March 21, 2000. See Credit Bancorp I, 194 F.R.D. 457. Subsequently, on May 22, 2000, Dillon, another customer, also moved for leave to intervene, which motion was granted on August 16, 2000. See Credit Bancorp VIII, 2000 WL 1170136.
On May 26, 2000, the SEC submitted the SEC Plan for a partial distribution of the assets of the Receivership estate, entitled "Plan of Partial Distribution of Disgorgement," for approval by this Court. Oil June 6, 2000, the Stappas Intervenors submitted the Stappas Plan. Oral argument was heard regarding the SEC and Stappas Plans on June 7, 2000.
At the hearing on June 7, 2000, various objections were raised to the SEC Plan. Counsel for SECO, Centigram, and Ray raised essentially the same objection, namely, that it would be premature for this Court to approve a partial distribution of the Receivership assets because, according to these intervenors, the Commission had failed to prove that the business putatively operated by Credit Bancorp was a Ponzi scheme.See Transcript of Proceedings, June 7, 2000, at 10, 11, 15.
In response to these objections, the Court directed the SEC and the Receiver to provide additional evidentiary material regarding the nature of the Credit Bancorp scheme. See Transcript of Proceedings, June 7, 2000, at 37. Subsequently, and in compliance with this directive, the Receiver submitted a Declaration (the "6/21/00 Receiver Decl.") and exhibits, and the SEC submitted Declarations by Scott R. Frost (the "6/21/00 Frost Decl." and "7/21/00 Frost Decl.") and exhibits. Evidence regarding the nature of the Credit Bancorp scheme is also contained in other submissions in this action, including the Receiver's Declaration of June 28, 2000 (the "6/28/00 Receiver Decl.") and exhibits, the Affidavit of Scott R. Frost of November 16, 2000 (the "Frost Affidavit") and exhibits, testimony, and admissions.
Also at the hearing on June 7, the Court set a schedule whereby it invited the customers of Credit Bancorp to submit comments regarding the proposed plans by June 28. 2000, and the SEC to respond by July 5, 2000.See Transcript of Proceedings, June 7, 2000, at 37-39. Shortly thereafter, the Receiver notified the Credit Bancorp customers by letter of this schedule and invited them to submit comments by sending letters to his attention. See Letter from Oliver Metzger to the Court of July 5, 2000 [hereinafter "7/5/00 Receiver Letter"] (referencing earlier correspondence). Due to the volume of submissions received, the SEC was later granted an extension of time to reply until July 12, 2000. See Letter of Thomas Melton to the Court of June 30. 2000.
On June 28, 2000. the SECO Intervenors submitted an additional proposed plan of partial distribution, the SECO Plan. In light of this submission, by letter of July 5, 2000, the Receiver made a request, in which the SEC joined, that the Court extend the deadline for submission of customer comments to July 17, 2000, and the deadline for the SEC's response to July 21, 2000. See Receiver Letter of July 5, 2000. This request was granted, and submissions were received regarding the SECO Plan through July 21, 2000.
Commencing in August 2000, the Receiver began negotiations with the Intervenors in an attempt to reach a consensus regarding an appropriate distribution plan. At the direction of the Court, the SEC did not participate in these negotiations. A consensus plan was not achieved. Thereafter, the Receiver formulated the Compromise Plan, which plan was sent by the Receiver to the SEC and counsel for the Intervenors on September 29, 2000. The SEC submitted the Compromise Plan and copies of comments by certain Intervenors to the Court on October 11, 2000, pursuant to a "Transmittal Memorandum." The Receiver sent the Transmittal Memorandum and accompanying exhibits to the non-intervening customers on October 13, 2000. Oral argument was heard regarding the Compromise Plan on October 18, 2000, at which time the matter was deemed fully submitted. However, pursuant to this Court's order, customers were given until November 1, 2000, to comment regarding the Compromise Plan, and those comments were transmitted by the Receiver to the Court on November 3, 2000.
In addition, several of the financial institutions with which Credit Bancorp maintained margin accounts have submitted objections to the Compromise Plan on the ground that it does not adequately protect their alleged security interests in certain stock held as security for margin loans obtained by Credit Bancorp. Deutsche Bank submitted its objections by way of a motion filed November 8, 2000, while the other institutions did so by way of letters to the Court.
By Joint Notice of Motion on June 12, 2000. the SECO Intervenors filed the instant motion for partial summary judgment. The relief requested is made by reference to certain claims from their complaints in intervention. See Joint Notice of Motion at 2. The referenced claim in SECO's complaint states that SECO is entitled to a declaration that:
(a) [SECO] is the sole equitable and beneficial owner of the 8,000,000 shares of Vintage stock deposited pursuant to the CFA and Trust Agreement, and all additional shares of VPI stock obtained as a result of the reinvestment of dividends or distributions therefrom. . .
(c) SECO is entitled to the immediate return and to exclusive possession and control over such stock.
SECO Amended Complaint in Intervention ¶ 75(c).
The referenced claim in Ray's complaint states that:
Credit Bancorp is . . . the constructive trustee of Plaintiff-Intervenor's Titan stock for the benefit of the Ray Trust, and should be ordered to return forthwith the Titan stock to the Ray Trust.
Ray Complaint ¶ 61.
Submissions were received regarding the motion for partial summary judgment through July 14, 2000, at which time the matter was deemed fully submitted.
On August 9, 2000, this Court approved a partial consent judgment of permanent injunction between the SEC and the Receiver, acting on behalf of Credit Bancorp (the "Partial Consent Judgment"), enjoining Credit Bancorp from engaging in further violations of the federal securities laws and ordering Credit Bancorp to disgorge and restore to investors all of the funds derived from the operation of the business of Credit Bancorp plus prejudgment interest. See Partial Consent Judgment.
A related action is the Third Party Complaint by the Receiver against Certain Underwriters at Lloyds, London, et al. ("Lloyds") seeking to enforce certain insurance policies issued to Credit Bancorp (the "Coverage Action"). Actions against Lloyds have also been initiated by certain customers and, indeed, certain of the defendants in this action. The Coverage Action was filed on February 23, 2000, and is presently in discovery with some dispositive motions scheduled for argument early in 2001.
By motion filed November 8, 2000, Deutsche Bank moved to intervene in this action. Submissions were received and oral argument was heard on November 22, 2000, at which time the matter was deemed fully submitted.
Because the interests of the SECO Intervenors are a critical element of each of the proposed plans of distribution, resolution of their motion for partial summary judgment precedes the approval of the Compromise Plan. Similarly, the facts relating to the partial summary judgment motion precede the facts relating to the status of the receivership, although all the factual findings are relevant to consideration of the proposed plans of distribution.
Findings of Fact
Facts Relating To The Credit Bancorp Transactions With The SECO Intervenors And Other Customers
In connection with the SECO Intervenors' motion for partial summary judgment, the SECO Intervenors and the Receiver submitted Rule 56.1 Statements, declarations, and exhibits. In addition, in order to make the factual findings necessary to resolve the motion for a partial distribution, the Court directed the SEC and the Receiver to submit evidence regarding the operation of the Credit Bancorp scheme, the status of the receivership estate, and the effect of each proposed plan on the customers. The evidence submitted includes, inter alia, declarations, bank records, brokerage records, Credit Bancorp solicitation materials, Credit Bancorp customer statements, copies of agreements executed by customers, customer deposit records, and reports generated by the Receiver's accounting firm. The facts are not disputed except as otherwise noted.
At the hearing on June 7, 2000, the Court invited any party to propose an evidentiary hearing if it believed that one was required in order to resolve the motion for approval of a plan of partial distribution. Although the parties differ in certain respects as to their interpretations of the documentary evidence, no party has indicated that it considers this evidence inadequate to resolve the instant motion, and no evidentiary hearing has been requested. Therefore, this motion will be resolved based on the documentary evidence.
Stephenson is the Chairman of the Board of Vintage Petroleum, Inc. ("Vintage"), an oil and gas company. See Stephenson Decl. ¶ 3. Vintage stock is publicly traded on the New York Stock Exchange. See id. ¶ 6. Stephenson, directly or indirectly, owns and controls a significant portion of the outstanding common stock of Vintage. See id. ¶¶ 4, 5.
SECO is a Texas general partnership formed by Stephenson in 1987. See Stephenson Decl. ¶ 8. Stephenson is, and always has been, the majority general partner of SECO. See id.
In March 1999, an agent of Credit Bancorp contacted Stephenson to solicit SECO's participation in Credit Bancorp's "insured credit facility program". See Stephenson Decl. ¶ 10. Credit Bancorp represented to SECO that it would extend a line of credit which if drawn upon was to be collateralized by SECO's shares of Vintage stock. See id.
On June 21, 1999, Stephenson, as general partner of SECO, and Blech, as President and CEO of Credit Bancorp, executed a "CBL Credit Facility Agreement" (the "SECO CFA"). See Stephenson Decl. Exh. 1. The SECO CFA was also executed by Brandon as "Trustee." See id. Also on June 21, 1999, J. Frederick Storaska ("Storaska"), as President of SECO, Brandon, as Trustee, and Blech executed a "Trustee Engagement Letter" (the "SECO Trustee Letter"). See Stephenson Decl. Exh. 1. The SECO Trustee Letter provides that it is made part of and incorporated into the SECO CFA. See id.
The SECO CFA includes the following provisions:
1.6 CBL will remit to Trustee, as Trustee for SECO, a calendar quarterly dividend of not less than one and one quarter percent (1.25%) of the "Unencumbered Balance" . . . of the Assets held as collateral for the credit facility (the "Dividend")
2.3 SECO will deliver to Trustee the specified fungible assets . . . to serve as collateral for the Credit Facility and to be held in the United States by one or more United States custodian facilities. . .
3.11 Upon the occurrence of any of the following circumstances, Trustee shall immediately and in any event within ten days return and deliver the assets to SECO: (1) upon the request of SECO for any reason whatsoever . . . (3) any attempt of a third party, including a bankruptcy trustee or creditors of CBL, to cease, attach or otherwise make claim against the assets;
4.1 All parties hereto acknowledge and agree that beneficial ownership to the assets shall at all time remain with SECO in the absence of default by SECO respecting advances, if any, made under this agreement.
4.2 CBL and Trustee represent and warrant that the Trustee shall have legal title to the assets and that SECO shall retain equitable title and beneficial ownership at all times including following the deposit of the assets into the account, and that the assets remain an asset of SECO and do not become an asset of CBL.
4.4 Any distribution by the issuer of the assets paid in the form of dividends, coupons, interest or capital gains during the term of the agreement will belong solely to SECO.
Stephenson Decl. Exh. 1.
The SECO Trustee Letter provides in relevant part that:
I [Brandon] am the signing attorney-in-fact for all CBL Trustee accounts. These [Vintage] securities are to be held by me in a CBL account and may not be sold, pledged, assigned, margined, liened, hypothecated, or otherwise disposed of except as provided for in the CFA . . . as the securities are being delivered solely as collateral for any advance SECO may obtain under the credit facility with CBL, beneficial ownership is retained by SECO.
Stephenson Decl. Exh. 1.
Credit Bancorp provided a model transfer instruction letter and precise transfer instructions for SECO to follow in order to deliver the Vintage shares. See 6/28/00 Receiver Decl. Exh. 3. The model transfer letter and instructions made no reference to a trust account. See id.
On June 25, 1999, SECO directed that 2,000,000 shares of Vintage stock be transferred into each of three different brokerage firm accounts "FBO" (for the benefit of) or "FFC" (for further credit to) Credit Bancorp, and that 2,000,000 shares of Vintage stock be transferred to a Credit Bancorp account designated only by number, for a total transfer of 8,000,000 Vintage shares. See Stephenson Decl. Exh. 2. Each instruction provided that the transfer was to be "Free Delivery." See id.
SECO maintains that it delivered the 8,000,000 shares of Vintage stock "pursuant to the terms of the CFA and the [Trustee] Letter Agreement." SECO Rule 56.1 Statement ¶ 9. However, this issue of fact is disputed. See Receiver Rule 56.1 Statement at 1-2. The SECO CFA provides that SECO would "deliver to Trustee the specified fungible assets." Stephenson Decl. Exh. 1 at ¶ 2.3. The SECO transfer instructions, however, provided for delivery into accounts FBO or FFC Credit Bancorp, or into a Credit Bancorp account designated only by number. See Stephenson Decl. ¶ 2. Thus, the Receiver maintains that the SECO transfer was not pursuant to the terms of the CFA and Trustee Letter.See Receiver Rule 56.1 Statement at 1-2.
SECO maintains that, subsequent to SECO's initial deposit of the 8,000,000 shares of Vintage stock into the four designated brokerage firm, and in violation of the SECO CFA, Credit Bancorp transferred the Vintage stock to a variety of other institutions holding brokerage accounts for the benefit of Credit Bancorp. See Stephenson Decl. ¶ 17, Exh. 3. The Receiver disputes this version of events to the extent that SECO intends to suggest that the initial deposit of Vintage stock into the four designated Credit Bancorp accounts was not itself in violation of the SECO CFA. See Receiver Rule 56.1 Statement at 2.
The Vintage stock can all be traced directly from the initial transfer from SECO to the following institutions: Ameritrade, Charles Schwab, Chase Investment, Credit Suisse Private Banking, Deutsche Bank, Dreyfus, ING, Legg Mason, Paine Webber Int'l, Pershing, Tasin Co, and TD Evergreen. See Stephenson Decl. ¶ 18 and Exh. 4. All of the Vintage stock now being held by the Receiver, or sought to be held by the Receiver, namely, the 8 million shares deposited by SECO plus 938 shares bought with reinvested dividends from that deposit, is stock deposited by SECO or derived directly therefrom. See id. ¶ 19 and Exh. 5.
According to a recent submission by SECO, the number of additional shares has increased to 1,814. See 11/16/00 Donald L. Kahl. Decl.
On or about February 2, 1999, Ray, as trustee of the Ray Trust, under Deed of Trust dated June 27, 1996 (the "Ray Trust"), and Blech, as President and CEO of Credit Bancorp, executed an insured credit facility agreement (the "Ray CFA"). See Ray Decl. Exh. 1. Also on or about February 2, 1999, Ray, Blech, and Brandon, as Trustee, executed a "Trustee Engagement Letter" (the "Ray Trustee Letter"). See Ray Decl. Exh. 2.
The relevant terms of the Ray CFA are identical to the terms of the SECO CFA set forth above, with one exception, namely, that the Ray CFA does not expressly grant legal title of the Titan shares to Brandon while the SECO CFA does grant legal title of the Vintage shares to Brandon.Compare SECO CFA, Art. IV "Warranties and Guarantees" § 4.2 with Ray CFA, Art. IV, "Warranties and Guarantees."
In a letter dated February 3, 1999, Ray instructed the transfer agent for his stock that 186, 494 shares of The Titan Corporation ("Titan"), held by Ray and his wife, as trustees of the Ray Trust, were "to be delivered to Credit Bancorp via DWAC." See 6/28/00 Receiver Decl. Exh. 4. On May 5, 1999, 186, 494 Titan shares were delivered to Credit Bancorp accounts at three different brokerage firms: 75,000 shares at Alex Brown Sons, 36,000 shares at Charles Schwab, and 75, 494 shares at Swiss American Securities, Inc. See Ray Decl. ¶ 4. As a trustee of the Ray Trust, Ray never agreed and never intended to transfer any ownership of the Titan. stock to Credit Bancorp. See Ray Decl. ¶ 5.
of course, the statement by Ray in his declaration that he never "agreed" to transfer ownership would not be proper if it were meant to express a legal conclusion, and it is not so construed herein.
Ray maintains that the Titan shares were deposited, in accordance with the terms of the Ray CFA and Trustee Letter, into what Ray was advised would be insured trustee accounts. See Ray Rule 56.1 Statement ¶ 3. This issue of fact is disputed. The Ray CFA provided that Ray would "deliver to Trustee that certain Collateral [that was the subject of the agreement]." See Ray Decl. Exh. 1 at ¶ 2.3. However, Ray's transfer instruction letter directed that the stock "be delivered to Credit Bancorp via DWAC," rather than to the Trustee. See 6/28/00 Receiver Decl. Exh. 4. Thus, the Receiver maintains that the transfer of stock was not in accordance with the terms of the CFA and Trustee Letter. See Receiver Rule 56.1 Statement at 3.
Ray also maintains that he never authorized Credit Bancorp to deposit the Titan stock in an account for the benefit of Credit Bancorp, or authorized Credit Bancorp to margin that stock. See Ray Rule 56.1 Statement ¶ 7. This issue of fact is also disputed to the extent that Ray intends to suggest that the Ray Trust did not authorize the transfer of Titan stock to Credit Bancorp. See Receiver Rule 56.1 Statement at 3. Ray's instructions to his transfer agent were that the shares were "to be delivered to Credit Bancorp via DWAC." See 6/28/00 Receiver Decl. Exh. 4.
If the stock to be transferred bore restrictive legends Credit Bancorp directed its customers to instruct their transfer agents to remove the legends before transfer. See 6/28/00 Receiver Decl. Exh. 7. Removal of the restrictive legends, required an opinion of counsel, which the customer would provide to the transfer agent. See id. Exh. 4. Ray provided an opinion of counsel letter to his transfer agent to remove restrictive legends from the Titan stock. See id.
On January 6, 2000, Ray, acting on behalf of the Ray Trust, terminated the Ray CFA and Trustee Letter. See Ray Decl. ¶¶ 8, 9 and Exhs. 3, 4. The Titan shares have not been returned to Ray. See Ray Decl. ¶ 10. At present, 75,000 shares of Titan stock are held at Deutsche Bank (Alex Brown's successor), 36,000 shares are held at Charles Schwab, and 75, 494 shares are held at Legg Mason. See Ray Decl. ¶ 11 and Exh. 5.
Neither SECO nor Ray availed themselves of the opportunity to draw down upon the credit facility. See Stephenson Decl. ¶ 15; Ray Decl. ¶ 6. They did receive "custodial dividend" payments. Specifically, SECO received a prepaid dividend payment on June 29, 1000 of $1,002,500, and another dividend payment of $204,533.33 on October 26, 2000; Ray received a dividend payment of $17,711.56 on October 25, 1999. See 6/21/00 Receiver Decl. Exh. 5. These payments were made from Credit Bancorp's account with Bank of America. See id.
Credit Bancorp operated a fraudulent investment scheme from at least 1997 until the filing of this suit by the SEC on November 17, 1999. See generally 6/28/00 Receiver Decl.; 6/21/00 Receiver Decl.; 6/21/00 Frost Decl. Credit Bancorp solicited customers to deposit securities, cash, and other assets to be held in trust with the promise of a return in the form of a "custodial dividend" based upon a percentage of the market value of the deposits, as well as to invest cash and mutual funds to be managed by Credit Bancorp and invested at above-market rates. See 6/21/00 Receiver Decl. ¶ 3 and Exhs. A, B, D; 6/21/00 Frost Decl. ¶¶ 17, 18 and Exh. G. SECO and Ray were two of approximately two hundred Credit Bancorp customers. See 11/6/00 Receiver Decl. Exh. 2.
In soliciting customers, Credit Bancorp described the "insured credit facility" as a vehicle through which Credit Bancorp was able to generate revenue from "riskless arbitrage" through major European banks. See 6/28/00 Receiver Decl. Exh. 1 at CCS 717, CCS 720. Prospective customers were told that in order to take advantage of this riskless moneymaker Credit Bancorp required an "off-balance sheet trading line of credit" established with Swiss banks. Id. at CCS 717, CCS 719. It was further claimed that in these arbitrage transactions "the arbitrage trade itself serves as collateral." Id. at CCS 718. Customers were told that as customers deposited cash and stock with Credit Bancorp, Credit Bancorp would be able to show ever greater off-balance sheet assets, and thus would be able to increase its credit line with European institutions and fund the riskless arbitrage. Id. at CCS 717-719.
Customers deposited assets with Credit Bancorp in two principal ways. Most, like SECO and Ray, deposited securities and/or cash pursuant into Credit Bancorp accounts at various brokerage firms. See 6/21/00 Frost Decl. ¶ 8; 6/28/00 Receiver Decl. Exh. 3; Stephenson Decl. Exh. 2. Approximately 93 customers, namely, the customers of Advisor's Capital Investments, Inc. ("Advisor's Capital"), otherwise known as the "Bob Mann customers," directed their deposits of cash and mutual funds with Advisor's Capital into the Credit Bancorp "insured securities strategy program." See 6/21/00 Receiver Decl. ¶ 4 and Exhs. A, B; 6/21/00 Frost Decl. ¶ 17 and Exh. G.
So named for the principal of Advisor's Capital.
The deposits of the Bob Mann customers total approximately $10 million and represent well under ten percent of the total customer assets taken in the Credit Bancorp fraud. See 11/6/00 Receiver Decl. ¶¶ 7, 12 and Exhs. 2, 4.
Although the CFAs provided that assets were to be delivered to Brandon, as Trustee, the CFA customers wired their securities directly into brokerage accounts FBO or FFC Credit Bancorp, or into Credit Bancorp accounts designated only by number. See. e.g., Stephenson Decl. ¶ 2; 6/28/00 Receiver Decl. Exh. 4. In addition, in cases where the securities bore restrictive legends Credit Bancorp instructed the customer to remove those legends, which required an opinion of counsel such as the one provided by Ray. See 6/28/00 Receiver Decl. Exhs. 4, 7.
Credit Bancorp promised customers who deposited securities that those securities would not be sold, pledged, hypothecated or otherwise encumbered. See, e.g., 6/21/00 Receiver Decl. Exh. A. Credit Bancorp represented to the Bob Mann customers that their funds were being invested in various Rydex mutual funds. See 6/21/00 Receiver Decl. ¶ 5 and Exh. D.
Credit Bancorp, contrary to its assurances, misappropriated the assets entrusted to it by the customers. The funds invested by the Bob Mann customers were immediately converted and directed to a Credit Bancorp account with Credit Suisse in Geneva (the "Credit Suisse account") rather than being invested in Rydex mutual funds. See 6/21/00 Receiver Decl. ¶ 5 and Exhs. C, D; 6/21/00 Frost Decl. ¶¶ 18, 19.
The assets deposited by other Credit Bancorp customers, primarily in the form of stocks but also in the form of cash, bonds, and mutual funds, were deposited into brokerage accounts in. the name of Credit Bancorp with various securities firms. See 6/21/00 Frost Decl. ¶¶ 5, 8. Blech was the signatory on the brokerage accounts. See 6/21/00 Frost Decl. ¶ 5 and Exh. B. Credit Bancorp then pledged many of the deposited securities as security for margin loans. See 6/21/00 Receiver Decl. ¶ 6 and Exh. E. Credit Bancorp subsequently encumbered a substantial portion of the securities deposited by customers by pledging those securities as collateral for margin debt incurred with various brokerage houses. See 6/21/00 Loewenson Decl. ¶¶ 16-23 and Exh. E. substantial options trading was conducted in the brokerage accounts in which the securities were held, increasing the margin loans. See 6/21/00 Frost Decl. ¶ 21. Credit Bancorp also sold some of its customers' stock outright. See. e.g., Frost Aff. ¶ 19 and Exh. M.
Credit Bancorp shifted funds and securities regularly among brokerage accounts, and neither segregated customer deposits in any way within any of the brokerage accounts nor earmarked a particular customer's deposited assets for use to pay that customer's custodial dividend. See 6/21/00 Receiver Decl. ¶¶ 8, 9; 6/21/00 Frost Decl. ¶ 8. There were several occasions on which deposits of securities were returned to customers by replacing the returned security in a brokerage account with another customer's deposited security, so as to prevent a margin call or to permit further loans against the margin accounts. See 6/21/00 Receiver Decl. ¶¶ 24-31 and Exhs. G-M.
The only exception were Leonid Shapiro, Jeff and Helen Hoyak, and Lorraine Jankowski, whose assets were segregated from other customers' deposits in separate accounts in Credit Bancorp's name but designated as for the benefit of the individual customer. See 6/21/00 Receiver Decl. ¶ 8 n. 1.
The Credit Suisse account, which contained approximately eighteen sub-account numbers, contained securities and cash deposits under the control of Credit Bancorp. See 7/21/00 Frost Decl. ¶ 3 and Appendix Exh. 28. Funds and securities were frequently moved among the sub-accounts, and customer securities were used as collateral for loans to a trading/cash account. See 7/21/00 Frost Decl. ¶¶ 3, 4.
The Credit Suissa account funds and proceeds from the margin loans were used for: (1) payments to customers in the form of custodial dividends, loans secured by customer deposits, and the return of deposited funds; (2) Credit Bancorp operating expenses; (3) Credit Bancorp investments; (4) options trading; and (5) Blech's personal expenses. See 6/21/00 Receiver Decl. ¶ 7; 6/21/00 Frost Decl. ¶¶ 4, 6, 11-13, 19 and Exh. E.
Immediately upon depositing shares into a Credit Bancorp account, the customer would receive a "prepaid" custodial dividend, with additional dividends following each quarter. See 6/21/60 Frost Decl. ¶ 11. Contrary to its claims that it was engaging in "riskless arbitrage," Credit Bancorp was generating these dividends from the deposits made by other customers rather than from sophisticated arbitrage transactions in Europe. See 6/21/00 Receiver Decl. ¶¶ 15-21 and Exh. E; 6/21/00 Frost Decl. ¶¶ 21-24.
All customer proceeds, whether from the margin loan proceeds from the deposits of the Bob Mann clients' cash into the Credit Suisse account or the margin loan proceeds from the brokerage accounts, were pooled and commingled in Credit Bancorp accounts at the Bank of America and Commerce Bank prior to distributions being made to customers. See 6/21/00 Receiver Decl. ¶ 9 and Exhs. E, F. and G; 6/21/00 Frost Decl. ¶¶ 6, 9, 13 and Exhs. C, D. The signatories on the Bank of America and Commerce Bank accounts were, respectively Virginia Allen ("Allen"), Credit Bancorp's North American Managing Director, and Thomas Rittweger ("Rittweger"), Credit Bancorp's Director of Marketing and Administration. See 6/21/00 Frost Decl. ¶ 3.
Among the assets currently held by the Receiver are (1) the 8,000,000 Vintage shares deposited by SECO, plus shares bought with reinvested dividends from the Vintage stock, located in accounts with a dozen different financial institutions, see Stephenson Decl. ¶ 19 and Exh. 5, and (2) 75,000 shares of Titan stock located in an account at Deutsche Bank (Alex Brown's successor) and 75, 494 shares of Titan stock located in an account at Legg Mason, see Ray Decl. ¶ 11 and Exh. 5.
Credit Bancorp was not engaged in "riskless arbitrage" or any other type of risk-free trading. See 6/21/00 Frost Decl. ¶ 21. Indeed, the trading activity in which Credit Bancorp did engage, which was primarily options trading, resulted in significant losses. See id. ¶ 23. There was no material source of income for Credit Bancorp other than the customers' deposits of cash, cash equivalents and securities. See id. ¶ 22, 24. By the time the complaint in this action was filed, Credit Bancorp had dissipated tens of millions of dollars of its customers' assets. See generally 6/21/00 Receiver Decl.; 6/28/00 Receiver Decl.; 6/21/00 Frost Decl. In other words, Credit Bancorp operated a Ponzi scheme.
Facts Relating To The Receivership
The order appointing the Receiver directed that the Receiver marshal the assets under Credit Bancorp's control. See January 21 Order. The order also directed the Receiver not to sell any securities without further order of this Court and the Receiver not to return to Credit Bancorp customers any securities or other assets deposited with Credit Bancorp or into an account in the name of Credit Bancorp without further order of this Court. See id.
As of October 4, 2000, the Receiver had control over approximately $190 million in securities and cash that appear either to have been initially deposited by customers or Credit Bancorp or to be derived from such deposits. See 11/6/00 Receiver Decl. ¶ 9. There are additional assets valued at approximately $39.9 million, primarily in the form of securities but also in the form of cash and cash equivalents, located in Credit Bancorp accounts with European financial institutions which do not presently recognize the Receiver's authority. See 11/6/00 Loewenson Decl. ¶ 20 and Exh. 3. See 11/6/00 Receiver Decl. ¶ 20 and Exh. 3. These assets have been frozen at the request of the SEC. but their repatriation has not been obtained. See SEC Mem. Supp. Plan Partial Dist. at 3. The SEC and the United States Department of Justice have initiated inter-governmental requests to obtain the return of these assets.
This is the amount after deducting the value of margin loans at those institutions. Although the validity of the European institutions' security interests in the assets deposited with them has yet to be determined, the safest assumption is that those interests are valid.
The estimated current market value of all customer claims based on deposits of securities, defined as the number of shares deposited minus the total number of shares returned prior to the asset freeze, is approximately $265 million. See 11/6/00 Receiver Decl. ¶ 12 and Exh. 2. If the shares are valued as of the TRO, the estimated value of these claims is approximately $197 million. See id. If valued as of the date of deposit, the amount is approximately $203 million. See id. In addition, the estimated value of the claims based on cash deposits by the Bob Mann customers is some $10 million. See id. ¶ 12 and Exh. 2. Finally, there are outstanding margin loans on various brokerage accounts in the amount of approximately $30 million, which loans appear to be secured by assets deposited with those brokerage houses. These loan amounts, and the continuously-accruing interest thereon, have not been deducted from the $190 million figure referenced above as the amount of assets under the Receiver's control. See id. ¶ 9 n. 3, 19.
The $30 million figure includes the margin loans with the European institutions. Some $28 million of this amount is associated with domestic accounts. As with the European institutions, the validity of the brokerage houses' security interests in these assets has yet to be determined. Although the Receiver has been exploring possible challenges to the validity of those interests — as have certain intervenors — the safest assumption is that these security interests are valid.
According to the complaint in the Coverage Action, there is a large contingent asset, namely, coverage under Credit Bancorp's insurance policies. See Coverage Action Compl. ¶ 27 (identifying insurance coverage as "largest contingent asset of Credit Bancorp"). Indeed, if the Coverage Action and other similar actions are successful, the customers may achieve virtually complete relief. See id. ¶¶ 23, 26, 27 (alleging that insurance policies cover inter alia losses to customers, estimated at $50 million or more). However, no insurance monies have been obtained at this time.
Thus, the assets under the Receiver's control, while substantial, are insufficient at the moment to provide for a full recoupment of the losses of all the Credit Bancorp customers.
Since the various dates of investment, some customers' assets have increased in value while other customers' assets have declined. Fluctuations in the value of these assets have also occurred between the date of investment and the date of the asset freeze, and between the date of the asset freeze and the present time. For example, the value of the Vintage Petroleum stock deposited by SECO was approximately $83.9 million at the time of deposit, had increased to approximately $102 million as of the asset freeze, and was valued at approximately $180 million as of September 7, 2000. See 11/6/00 Receiver Decl. Exh. 2. Many other customers also experienced increases in the value of the assets they had deposited. See id. By contrast, the value of the securities deposited by the Cole-Hatchard Family declined from approximately $1.8 million on the date of deposit to approximately $536,000 on the date of the asset freeze to approximately $374,000 on September 7, 2000. See id. Many other customers also saw declines in the value of their stock. See id. The only customers who were not affected in this manner are the Bob Mann customers, as their deposits were in the form of cash. Conclusions of Law
I. The SECO Intervenors' Motion For Partial Summary Judgment Is DeniedA. The Standard For Summary Judgment
These figures do not account for missing securities, returned securities, custodial dividend payments, or loans to customers.
As noted earlier, it was represented to these customers that their cash would be invested in mutual funds. However, that never occurred.
Rule 56(c) of the Federal Rules of Civil Procedure provides that a motion for summary judgment may be granted when "there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." The Second Circuit has repeatedly noted that "as a general rule, all ambiguities and inferences to be drawn from the underlying facts should be resolved in favor of the party opposing the motion, and all doubts as to the existence of a genuine issue for trial should be resolved against the moving party." Brady v. Town of Colchester, 863 F.2d 205, 210 (2d Cir. 1988) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 330 n. 2 (1986) (Brennan, J., dissenting)); see Tomka v. Seiler Corp., 66 F.3d 1295, 1304 (2d Cir. 1995); Burrell v. City Univ., 894 F. Supp. 750, 757 (S.D.N.Y. 1995). If, when viewing the evidence produced in the light most favorable to the non-movant, there is no genuine issue of material fact, then the entry of summary judgment is appropriate. See Burrell, 894 F. Supp. at 758 (citing Binder v. Long Island Lighting Co., 933 F.2d 187, 191 (2d Cir. 1991)).
The posture of this summary judgment motion is somewhat atypical in that the result of a denial of the SECO Intervenors' motion is not a trial of the claims. Rather, the result would be that the Vintage and Titan securities could be considered, like other receivership assets, for distribution pursuant to a plan adopted by this court. Summary judgment proceedings are sometimes employed in such situations. Compare United States v. Vanguard Inv. Co., 6 F.3d 222, 224-25 (4th Cir. 1993) (discussing district court's disposition of defrauded customer's claim for restitution of defrauded funds held in receivership pursuant to summary judgment motion) with SEC v. Elliott, 953 F.2d 1560, 1569-70 (11th Cir. 1992) (discussing district court's resolution of customers' claims for restitution of securities held in receivership pursuant to approval of plan for distribution of receivership assets). Denial of the instant motion is not, however, the last word as to how these or other assets may be distributed, as that will depend on the plan of distribution adopted. SECO and Ray have also submitted a proposed distribution plan which provides' that they are to recover the Vintage and Titan securities through tracing.
Materiality is defined by the governing substantive law. "Only disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment. Factual dispute that are irrelevant or unnecessary will not be counted."Anderson v. Liberty Lobby. Inc., 477 U.S. 242, 248 (1986). "[T]he mere existence of factual issues — where those issues are not material to the claims before the court — will not suffice to defeat a motion for summary judgment." Ouarles v. General Motors Corp., 758 F.2d 839, 840 (2d Cir. 1985).
For a dispute to be genuine, there must be more than "metaphysical doubt." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). "If the evidence is merely colorable, or is not significantly probative, summary judgment may be granted." Anderson, 477 U.S. at 249-50 (citations omitted).
B. The Law Governing The 33CC Intervenors' Claims
The SECO Intervenors maintain that their claims are governed by contract law, the Uniform Commercial Code ("U.C.C."), and the law of bailment. The Receiver maintains that these claims are governed by the law of federal equity receiverships and, more specifically, the law governing the distribution of assets to defrauded investors in such receiverships. As explained below, the Receiver is correct, and equitable principles apply to these claims.
The classic "Ponzi" scheme is a fraudulent investment scheme in which earlier investors' returns are generated by the influx of fresh capital from unwitting newcomers rather than through legitimate investment activity. See Cunningham v. Brown, 265 U.S. 1 (1924) (describing scheme of Charles Ponzi). The Second Circuit has described a Ponzi scheme as:
a scheme whereby a corporation operates and continues to operate at a loss. The corporation gives the appearance of being profitable by obtaining new investors and using those investments to pay for the high premiums promised to earlier investors. The effect of such a scheme is to put the corporation farther and farther into debt by incurring more and more liability and to give the corporation the false appearance of profitability in order to obtain new investors.Hirsch v. Arthur Anderson Co., 72 F.3d 1085, 1088 n. 3 (2d Cir. 1995)
There is no dispute that Credit Bancorp was engaged in a Ponzi-type operation. The issue of how the assets of an entity in federal receivership should be distributed to investors who have fallen victim to a Ponzi scheme has been addressed by several federal courts of appeal.See CFTC v. Topworth Int'l, Ltd., 205 F.3d 1107, 1115-16 (9th Cir. 1999); United States v. Durham, 86 F.3d 70, 72-73 (5th Cir. 1996);Vanguard, 6 F.3d at 226-27; Elliott, 953 F.2d at 1569-70. The fundamental principle which emerges from this case law is that any distribution should be done equitably and fairly, with similarly-situated investors or customers treated alike. See Cunningham, 265 U.S. at 13 ("[E]quality is equity."); Elliott, 953 F.2d at 1569; Durham, 86 F.3d at 73; Vanguard, 6 F.3d at 226-27. of course, what is equitable will depend on the circumstances of the case.
The SECO Intervenors urge that the operation consisted of two schemes rather than one, namely, a scheme involving customers who deposited securities and a scheme involving customers who deposited cash. This is consistent with the SECO Intervenors' general approach, which is that these claims should be determined in isolation from those of other Credit Bancorp customers. However, they do not contend that their characterization is an undisputed material fact, nor could they based on the evidence. On the contrary, the evidence is that Credit Bancorp operated one, albeit multifaceted, scheme. See Part I.C.2.,infra.
C. SECO And Ray Are Not Entitled To Summary Judgment Under The Law Governing Equity Receiverships1. There Is No Right To Tracing In Equity
It is typical in cases involving a receivership imposed on a corporate defrauder that the resources of the receivership estate are insufficient to allow all the victims of the fraud to recoup their losses, as is the situation here. See, e.g., Elliott, 953 F.2d at 1569. It is also not unusual for investors whose assets are traceable at the time the fraudulent operation is halted to claim that they are entitled to recover those assets in full, as the SECO Intervenors have done. See, e.g., Topworth, 205 F.3d at 1115-16; Elliott, 953 F.2d at 1569-70; Anderson v. Stephens, 875 F.2d 76, 77-80 (4th Cir. 1989). Nor are SECO and Ray the only Credit Bancorp customers who have taken this position. Indeed, at an earlier stage in this action the Receiver was "buffeted from all sides by demands for the return of assets" from numerous Credit Bancorp customers. Credit Bancorp I, 194 F.R.D. at 461.
Obviously, possessive pronouns used with respect to these assets are used simply for the sake of convenience, and do not constitute a legal conclusion by the Court as to the ownership of any given assets.
As was noted in Credit Bancorp I, federal courts overseeing equity receiverships imposed on a defrauder's estate have taken different approaches as to whether to approve the return of assets through tracing.See 194 F.R.D. at 463. Many have disallowed tracing in favor of a pro rata approach. See Topworth, 205 F.3d at 1115-16 (affirming District Court's approval of pro rata distribution plan); Durham, 86 F.3d at 73 (affirming District Court's approval of pro rata distribution plan even though majority of funds were traceable to specific claimants); United States v. Real Property Located at 13328 and 13324 State Highway, 89 F.3d 551, 553 (9th Cir. 1996) [hereinafter "Real Property"] (affirming District Court's refusal to allow tracing of defrauded investors' funds); Vanguard, 6 F.3d at 226 (affirming District Court's denial of restitution of proceeds, which were traceable, from sale of investor's real property); Elliott, 953 F.2d at 1569-70 (affirming District Court's rejection of restitution claim by defrauded investors as to securities which perpetrator of Ponzi scheme had not sold); SEC v. Pavarini, No. 88 Civ. 4897, 1989 WL 49365, at *2-3 (S.D.N.Y. May 3, 1989) (approving pro rata distribution plan); CFTC v. Franklin, 652 F. Supp. 163, 168 (W.D. Va. 1986) (approving pro rata distribution plan), rev'd on other groundssub nom Anderson v. Stephens, 875 F.2d 76 (4th Cir. 1989). Others have approved the return of traceable assets. See P.D. Ventures, 1991 WL 269982, at *2-*3 (approving return of "directly traceable" shares to particular investors who entrusted them to defrauder); see also Anderson, 875 F.2d at 77-80 (approving tracing of assets deposited after imposition of receivership).
Thus, while a court sitting in equity may allow tracing, there is no entitlement on the part of a defrauded customer to that measure as it may "frustrate equity." Real Property, 89 F.3d at 553; see Durham, 86 F.3d at 73 ("[W]hen a party can trace its assets, that party is entitled to seek a constructive trust or equitable lien on its portion of those funds that remain . . . [but] the court, in exercising its discretionary authority in equity, [is] not obligated to apply tracing.").
This principle recognizes that one of the key characteristics of a Ponzi scheme is that not all assets are immediately consumed by the perpetrator of the scheme. Rather, some assets are retained for a period of time before being used in connection with the fraud. Thus, whether at any given moment a particular customer's assets are still traceable is a "result of the merely fortuitous fact that the defrauders spent the money of the other victims first." Durham, 86 F.3d at 72. Under these circumstances:
To allow any individual to elevate his position over that of other investors similarly "victimized' by asserting claims for restitution and/or reclamation of specific assets based upon equitable theories of relief such as fraud, misrepresentation, theft, etc. would create inequitable results, in that certain investors would recoup 100% of their investment while others would receive substantially less .Elliott, 953 F.2d at 1569 (quoting District Court opinion); see also Real Property, 89 F.3d at 553 (where "the struggle over the res derived from fraudulent conduct is between innocent parties, tracing should not and will not apply"); Durham, 86 F.3d at 73 (affirming district court's refusal to impose constructive trust proper because it was "inequitable to allow [claimant seeking trust] to benefit merely because the defendants spent the other victims' funds first"); Vanguard, 6 F.3d at 227 (adopting reasoning of Elliott, 953 F.2d at 1569)
Finally, equitable principles may supersede rights an investor would have under other law to recover its assets through tracing. See Vanguard, 6 F.3d at 226 ("[E]ven if entitlement [to trace assets] under state law could be established, that wouldn't end the matter in this federal receivership."); Elliott, 953 F.2d at 1569 (affirming pro rata distribution plan because of inequity of affording some investors priority, through tracing, based on theories of equitable relief such as fraud, misrepresentation, and theft)
2. The SECO Intervenors Have Not Shown That They Are Entitled To Summary Judgment Under The Law Governing This Equity Receivership
The referenced claims in the SECO and Ray complaints, though styled somewhat differently, both seek a declaration that they are entitled to the immediate return of the securities that they deposited with Credit Bancorp, i.e., restitution. See Black's Law Dictionary 1313 (7th Ed. 1990) (restitution is the "[r]eturn or restoration of some specific thing to its rightful owner or status"). Restitution is a classic equitable remedy. LiButti v. United States, 178 F.3d 114, 120 (2d Cir. 1999) ("Restitution is not of mere right. It is ex gratia, resting in the exercise of a sound discretion; and the court will not order it where the justice of the case does not call for it . . .") (internal citation and quotation marks omitted).
SECO's complaint seeks a declaration that SECO is the "the sole equitable and beneficial owner" of the Vintage stock and that it "is entitled to the immediate return and to exclusive possession and control over [this] stock." Ray's complaint seeks a declaration that Credit Bancorp is the "constructive trustee" of the Titan stock and should be ordered to return the stock to Ray.
Ray seeks imposition of a constructive trust, also an equitable remedy, see Durham, 86 F.3d at 72-73 (citations omitted), though which trust Ray seeks restitution.
On the one hand, the SECO Intervenors object that they seek legal rather than equitable relief and therefore that equitable principles do not apply. This argument is discussed infra. On the other hand, they contend are entitled to recover their stock on equitable grounds as well.
Given that the assets of the receivership may well prove to be insufficient to provide for full recoupment by all customers of their losses, depending on the outcome of the insurance litigation, the relief sought by the SECO Intervenors would necessarily come at the expense of the remaining victims. Thus, while the SECO Intervenors might not obtain 100% recovery if their motion were granted — in that they state that their claims are subject to any valid margin liens — they would recover a much greater proportion of their assets than would other customers.
All of Credit Bancorp's customers knowingly entrusted their assets to Credit Bancorp, whether through the fictional insured credit facility and trustee arrangement into which the SECO Intervenors and others thought they were entering, or through the equally illusory investment management program offered to the Bob Mann customers. All of these customers relied upon certain representations made by Credit Bancorp as to what would be done with their assets and the returns they could expect. All were victimized, in that, contrary to the assurances they received, their assets were misappropriated.
Finally, the assets of all customers were made use of by Credit Bancorp pursuant to one, albeit multifaceted, scheme. Credit Bancorp freely transferred and mingled its customers' stock among various brokerage accounts. Those stocks were not segregated from each other or otherwise identified as being held for the benefit of any particular customer. Credit Bancorp also pooled and commingled in Credit Bancorp bank accounts its customers' cash deposits with proceeds from margin loans taken out against customers' securities. The commingled funds were then used for the fraudulent purposes of the Credit Bancorp scheme, including to pay returns to customers.
SECO points out that cash deposits were commingled with the proceeds of margin loans taken out against other customers' securities rather than with the securities themselves. This, however, is a distinction without a difference.
SECO and Ray, who entered the Credit Bancorp program in February and June of 1999, respectively, were two of the later-entering customers into the Credit Bancorp program. Indeed, SECO deposited its Vintage stock with Credit Bancorp just five months before the filing of this action by the SEC. Although neither SECO nor Ray's assets escaped the Credit Bancorp scheme unscathed, in that their securities were encumbered with margin debt and, in the case of Ray, some securities are missing, these assets are relatively intact compared to those of a number of other customers. However, the ability of SECO and Ray to trace their assets cannot be said to be anything other than "fortuitous." Durham, 86 F.3d at 72. Thus, the SECO Intervenors are similarly-situated to other Credit Bancorp customers whether those customers deposited securities or cash and whether those customers' assets are traceable or not.
At various points in this litigation SECO has urged that it is entitled to special consideration because it is the "largest victim" of the Credit Bancorp scheme. By this SECO means that the assets it handed over worth more money than those of any other customer. of course, whether this makes SECO the "largest victim," as compared with individual investors who had only their retirement monies to lose, is a matter of point of view. See Statement of Aubrey Lewis, Transcript of Proceedings, February 2, 2000, at 38 (describing loss of life savings); E-mail from William A. Masopust and Marilyn Masopust to Andrew Fields of June 26, 2000 (same); Letter from Charles F. Gavin to Loewenson of January 28, 2000 (same); Letter from David M. Albert, undated (lost $100,000 in IRA funds); Letter from Charles Savall to Loewenson of June 21, 2000 (lost $20,000 in IRA funds, representing 8 years of savings towards retirement)
This is a "struggle over [a] res derived from fraudulent conduct between innocent parties." Real Property, 89 F.3d at 553. Under these circumstances, the reasoning of the case law which has disallowed tracing as a remedy to defrauded investors is applicable, as it would be profoundly inequitable to grant the SECO Intervenors the relief they seek.
The SECO Intervenors object that the rationale for disallowing tracing does not apply here because the existing case law does not address a situation "where the customer provided identifiable property and the receiver's predecessor expressly agreed, and the applicable law independent of the agreement also provided, that it would have no ownership interest in such identifiable property." SECO Mem. Partial Summary J. at 13.
The fact that the SECO Intervenors provided "identifiable property" to Credit Bancorp does not distinguish this case. The Elliott customers transferred "identifiable property," i.e., securities, to the perpetrator of the fraud in that case. See 953 F.2d at 1568-69. Indeed, in contrast to the situation here, the securities in Elliott still had the names of the investors on them. See id. at 1568-69. The investor in Vanguard, although he sought to trace the cash value of his investment, had transferred a parcel of real property. See 6 F.3d at 224. Yet both theElliott and Vanguard courts held that the investors could be precluded from recovering their assets through tracing because of equitable concerns. See Elliott, 953 F.2d at 1569-70; Vanguard, 6 F.3d at 227.
In addition, neither the entitlement to recovery through tracing nor the practical ability to trace assets depends on those assets being "identifiable property" rather than cash. See. e.g., Durham, 86 F.3d at 72-73 (cash claimants whose funds could be traced to specific bank accounts sought recovery through tracing but were denied remedy on equitable grounds). Indeed, in SEC v. Black, 163 F.3d 188 (3d Cir. 1998), cited by the SECO Intervenors, the critical issue as to whether tracing was considered appropriate was whether a customers' assets — whether cash or securities — were maintained in the customer's own name or with a custodian bank named by the customer, rather than the nature of the asset itself. See id. at 192.
Nor does the fact that Credit Bancorp "expressly agreed" and "the applicable law provided" that it would not have an ownership interest in the SECO Intervenors' assets distinguish this case. As previously mentioned, the fact that the SECO Intervenors might be entitled under other law to recover their assets does not end the inquiry in this equity receivership because equitable concerns may supersede those other rights. In Elliott, where the defrauded investors sought recovery of their securities, rescission and restitution would have been appropriate contract remedies, yet the court held that those remedies would be disallowed as creating inequitable results. See 953 F.2d at 1569. InVanguard, the court held that whether or not rescission and restitution were available under state law, such remedies could be denied in the district court's discretion as being inequitable. See 6 F.3d at 226. InReal Property, the perpetrator of the fraudulent investment scheme posed as an investment advisor. See 89 F.3d at 552. Presumably, an agreement with an investment advisor would not provide the advisor with an ownership interest in his customer's assets — and applicable law would be to the same effect. Yet the court denied the investor's request to trace his assets. See Real Property, 89 F.3d at 553.
The SECO Intervenors have not shown why their alleged personal property or contractual rights should be treated differently from the rights of the parties in cases such as Elliott, Vanguard, and Real Property. Certainly, the language of the cases sweeps broadly. See Real Property, 89 F.3d at 553 ("[T]racing fictions should not be utilized under circumstances involving multiple victims and commingled funds.");Vanguard, 6 F.3d at 226 ("[E]ven if entitlement under state law could be established, that wouldn't end the matter in this federal receivership."); Elliott, 953 F.2d at 15780 ("[I]n equity, certain tracing rules should be suspended.").
Nor do the cases cited by the SECO Intervenors support their claim that they are entitled to recover their traceable assets. In Black, 163 F.3d 188, the court held that a freeze order imposed pursuant to an equity receivership was overly broad because it included assets held in accounts in the names of the clients of the defrauder and in financial institutions that were independent of the defrauder and his company. See id. at 196-97. Thus, the defrauder managed these accounts but, due to the way in which they were held, did not have "control" over them. See id. at 192, 196. Therefore, these assets were deemed to be the "assets of a nonculpable third party." See id. at 196-97. In the same case, by contrast, assets held in a pooled account in the name of the defrauder's investment company — i.e., in a manner similar to the Credit Bancorp scheme — could be frozen. See id. In Rodi Boat Co. v. Provident Tradesmens Bank Trust Co., 236 F. Supp. 935 (E.D. Pa. 1964), there was neither an SEC enforcement proceeding nor a receivership involved. The only case cited by the SECO Intervenors which involved a similar situation as the one here, and in which the court permitted tracing pursuant to a constructive trust, P.B. Ventures, 1991 WL 269982, at *2-3, is simply not persuasive here. Moreover, the P.D. Ventures court acknowledged that "[n]o specific distribution scheme is mandated so long as the distribution is `fair and equitable.'" See id. at *2 (citations omitted)
The SECO Intervenors also cite to Elliott for the proposition that the Receiver is seeking "`to bring money into the receivership from someone who was defrauded . . . [so that] [i]n effect, equity would be sanctioning further torment of a defrauded investor.'" SECO Mem. Partial Summary J. at 10 (quoting Elliott, 953 F.2d at 1574-75). This aspect of the Elliott decision, however, was concerned with an entirely different question, namely, whether a defrauded customer was entitled to "set off" an outstanding debt owed to the defrauder against his claim to a pro rata share in the receivership assets. See id. at 1572. The court concluded that as to this issue the customer was not similarly situated to customers who did not have such debts, and that a set off was appropriate because otherwise this victim would have ended up owing the receivership money. See id. at 1572 (directing that set off be approved in that customer's debt was greater than his pro rata share in receivership estate, so that absent set off customer would have owed receivership money).
Finally, the SECO Intervenors aver that the relief they seek is legal rather than equitable in nature, namely, a declaration of legal ownership under the common law of bailment and the U.C.C., and that therefore equitable principles do not control. Although properly characterizing the SECO Intervenors' claims is not without its difficulties — indeed, the SECO Intervenors themselves have not been entirely consistent in this regard — it is properly construed as a claim for restitution.
On the hand, they seek a declaration that they are entitled to the return of their securities, i.e., restitution, and, in the case of Ray, a constructive trust. See SECO Amended Complaint ¶ 75(c); Ray Complaint ¶ 61. On the other hand, they assert in their reply brief that their claims are legal because they seek "a declaration of legal ownership under the common law of bailment and pledge, and the UCC." See SECO Reply Mem. at 7.
Moreover, assuming arguendo that the relief sought were properly characterized as legal in nature, the authorities cited by the SECO Intervenors do not support their contention that claims at law may never be subordinated to equitable concerns in a case such as this one. Gorman v. Littlefield, 229 U.S. 19 (1913), is inapposite in that it involved a bankruptcy rather than an equity receivership and did not concern competing rights of fraud victims but, rather, the rights of a creditor of the bankrupt estate as compared with the rights of a customer of the bankrupt brokerage firm over shares deposited by the customer. See id. at 24-25. City of Philadelphia v. Lieberman, 112 F.2d 424 (3d Cir. 1940), concerned an insurer in receivership that had deposited securities in trust in order to qualify as a surety for contracts with the city of Philadelphia. See id. at 426. The district court's order that the securities be turned over to the receiver was reversed because the securities had been "placed in trust beyond the control of [the insurer]" and the city was entitled to the protection of the trust. Id. at 426. In the case of Credit Bancorp, however, despite the execution of letters engaging Brandon as a trustee, the securities were not transferred into trust accounts and were not beyond the control of Credit Bancorp. Finally, the bankruptcy authorities cited by the SECO Intervenors, while they could be persuasive by analogy, are not in this case.
The SECO Intervenors cite two passages from Gorman, see SECO Mem. at 16, however, only the passage beginning "No creditor could justly demand . . ." actually appears in that opinion. See Gorman, 229 U.S. at 25.
Therefore, whether the SECO Intervenors' claims are characterized as equitable or legal in nature, the SECO Intervenors have not shown that they are entitled to summary judgment on their claim to recover their stock under the law governing the distribution of assets to defrauded investors in a federal equity receivership.
3. The Receiver Does Not Simply Stand In The Shoes of Credit Bancorp For Purposes of The SECO Intervenors' Claims
The Receiver avers that, assuming the SECO Intervenors have legal rights under the contracts with Credit Bancorp or applicable law, these legal rights might entitle them to a monetary judgment against Credit Bancorp — even if equitable considerations might counsel against enforcement of such a judgment. See Vanguard, 6 F.3d at 227-28 (discussing possible claim by defrauded investor in Ponzi scheme for compensatory damages for breach of contract). As the SECO Intervenors have not asserted such a claim, further discussion of this question would be premature.
The SECO Intervenors attempt to avoid the import of the case law governing federal equity receiverships by contending that the Receiver merely stands in the shoes of Credit Bancorp. Therefore, the argument goes, the Receiver has no better grounds to prevent them from recovering their securities than would Credit Bancorp and, pursuant to the credit facility agreements, Credit Bancorp would have no, such grounds.
This argument is another variation on the SECO Intervenors' attempt to have their claims considered in isolation from those of the other customers. However, this is not a one-on-one contest between the SECO Intervenors and the Receiver. Rather, this is a case in which numerous victims of a fraud have competing claims to a limited receivership res. The relief sought by the SECO Intervenors would come at the direct expense of the other Credit Bancorp victims. As this Court noted inCredit Bancorp I, under these circumstances, "[t]he Receiver at once represents the interests of all and none of Credit Bancorp's customers. . . . To the extent that the Receiver the interests of all in mind, he is the adversary of the individual customer — whose concern is only for the return of his deposits." Credit Bancorp I, 194 F.R.D. at 461 (citing Elliott, 953 F.2d at 1577); cf. Teltronics. Ltd. v. Heyman, 649 F.2d 1236, 1239 (7th Cir. 1981) (rejecting. under Illinois receivership law, argument that receiver takes no better title to property than person subject to receivership, since receiver is empowered to manage the claims of defrauded rightful owners).
Moreover, the Receiver points out that the SECO Intervenors' theory, even if it were valid, is unworkable because most of the stock held in Credit Bancorp's accounts with broker-dealers are encumbered with margin loans. See 6/21/00 Receiver Decl. ¶ 6; 6/21/00 Frost Decl. ¶ 6. Unless those loans are paid off, something for which the receivership does not have sufficient funds, or the security interests declared invalid, there is no practical way to return all traceable stock.
The SECO Intervenors, as noted earlier, are not the only investors who have sought to recover their stock through tracing.
These are the kinds of concerns which can and should be taken into account by this Court in the exercise of its equitable powers. The cases cited by the SECO Intervenors do not warrant a different result. Most of them concern one-on-one contests between a receiver and a third party who claims to have secured status, as opposed a situation where the receiver faces competing claims of secured status to the same res. See East v. Crowdus, 302 F.2d 645, 645 (8th Cir. 1962) (customers of insolvent broker entitled to trace shares over receiver's objection that they had no better claim than general creditors); American Fuel Power Co. v. Vanston Bondholders Protective Comm., 151 F.2d 470, 481 (6th Cir. 1945) (receivership estate subject to mortgage lien); Powell v. Maryland Trust Co., 125 F.2d 260, 271-72 (4th Cir. 1942) (receivership subject to liens held by third parties); United States v. Mr. Hamburg Bronx Corp., 228 F. Supp. 115, 125-26 (S.D.N.Y. 1964) (receivership estate subject to state tax lien). Other cases were governed by state law and, while they could be persuasive, are not here. See Oler v. Lester Harding, 127 F.2d 963, 964 (3d Cir. 1942) (stating that "[t]he receiver has the right to possession of and deals only with the property interests of his insolvent" and approving tracing for those defrauded customers whose securities had not been sold).
The same is true of the other two cases cited by the SECO Intervenors, Cates v. Musgrove Petroleum Corp., 376 P.2d 819 (Kan. 1952); Clow Gasteam Heating Co. v. Hixson, 67 S.W.2d 619 (Tex.Ct.App. 1933)
Other cases cited by the SECO Intervenors concern different issues altogether. See Union Nat'l Bank of Chicago v. Bank of Kansas City, 136 U.S. 223, 234-235 (1890) (construing Missouri law as providing that deed of trust conveying personal property to secure payment of debts was mortgage only and not assignment for benefit of creditors); Lank v. New York Stock Exchange, 548 F.2d 61, 66 (2d Cir. 1977) (receiver may not pursue private right of action against SEC where corporation in receivership would not have such right). Another case actually undercuts the position taken by the SECO Intervenors. See Central Hanover Bank Trust Co. v. President and Dirs. of Manhattan Co., 105 F.2d 130, 131 (2d Cir. 1939) (bankruptcy reorganization includes property in which debtor did not have interest upon filing of bankruptcy petition because "although strictly . . . receiver has no better title than the defendant [debtor] whose possession he takes over . . . there are occasions when he may represent creditors when the defendant would have no standing").
Therefore, the SECO Intervenors cannot overcome the Receiver's opposition to the instant motion on the theory that the Receiver simply stands in the shoes of Credit Bancorp. Rather, this motion must be resolved in light of the many competing claims to the receivership estate and the equitable principles which apply to this situation.
D. The SECO Intervenors Are Not Entitled To Summary Judgment Under The U.C.C. or The Law Of Bailment
Although the SECO Intervenors' claims have been construed as equitable in nature, for purposes of the following discussion it will be presumed that they may be properly styled as legal claims under the U.C.C. and the law of bailment. However, as explained below, the SECO Intervenors are not entitled to summary judgment on this basis.
1. It Is Consistent With The U.C.C. To Apply The Law Governing Equitable Receiverships To The SECO Intervenors' Claims
a. The Relationship Between The SECO Intervenors and Credit Bancorp Is Governed By Revised Article 8 Part 5 of the U.C.C .
The Receiver and the SECO Intervenors concur that the relationship between Credit Bancorp and the customers who deposited securities with it is governed by Part 5 of Article 8 of the U.C.C., although they differ in certain respects as to how this section applies. Part 5, entitled "Security Entitlements," is the U.C.C. section which governs the "indirect" holding of securities by "securities intermediaries." Indirect holding means that the interest in a security is "held through an intermediary, rather than by holding a certificate or by registration with the issuer of the securities." U.C.C. Art. 8, L. 1997, c. 566, § 1, Legislative Intent — 1997 Revision of Article 8.
The CFAs between SECO and Ray, respectively, and Credit Bancorp provide that they will be governed by "the laws of the State of Kentucky and the United States of America." See Stephenson Decl. Exh. 1 ¶ 6.5; Ray Decl. Exh. 1. ¶ 6.4; see also 6/28/00 Receiver Decl. Exh. 2; Ray Decl. Exh. 2. Part 5 of Revised Article 8 has been adopted in Kentucky in substantially the same form as the uniform version of the U.C.C., and became effective in that state as of January 1, 1997. See Ky. Rev. Stat. Ann. §§ 355.8-501 to 355.8-511 (Baldwin 2000). Part 5 has also been adopted in New York in substantially the same form as the uniform version of the U.C.C., and became effective in that state as of October 10, 1997 See N.Y.U.C.C. §§ 8-501 to 8-511 (McKinney 1999-2000)
A "securities intermediary" is "a person, including a bank or a broker, that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity." U.C.C. § 8-102 (14). A "securities account" is:
[A]n account to which a financial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the financial asset.
U.C.C. § 8-501(a).
A "security entitlement" means "the rights and property interest of an entitlement holder with respect to a financial asset [including a security, see U.C.C. § 8-102(a)(9)(i)] specified in Part 5 [of Article 8]." U.C.C. § 8-102(a) (17); see U.C.C. § 8-503 Official Comment 2 ("A security entitlement is not a claim to a specific identifiable thing; it is a package of rights and interests that a person has against the person's securities intermediary and the property held by the intermediary."). A "security entitlement" can be acquired by a person when a securities intermediary "indicates by book entry that a financial asset has been credited to the person's securities account." U.C.C. § 8-501(b)(1). "The effect of concluding that an arrangement is a securities account is that the rules of Part 5 apply." U.C.C. § 8-501 Official Comment 1.
The Vintage and Titan stock made available to Credit Bancorp by the SECO Intervenors are held in the first instance through the Depository Trust Company ("DTC"), whose nominee, Cede Co., is the registered owner. See SECO Mem. Partial Summary J. at 11. Thus, prior to their dealings with Credit Bancorp, the SECO Intervenors held security entitlements as against their brokers in the Vintage and Titan securities, as opposed to direct interests in that stock. Credit Bancorp in the ordinary course of its business maintained on its records accounts for the SECO Intervenors and indicated by book entry that the assets transferred had been credited to these accounts. Credit Bancorp then issued regular statements to the SECO Intervenors reflecting these facts. See, e.g. 6/28/00 Receiver Decl. Exhs. 27, 29; 6/21/00 Receiver Decl. Exh. D. Under the agreements between Credit Bancorp and the SECO Intervenors, the intervenors would be entitled to exercise the rights of these securities. Thus, the SECO Intervenors had "securities accounts" with Credit Bancorp, a "securities intermediary," and the SECO Intervenors are holders of "security entitlements."
b. Equitable Rules Apply Because Revised Article 8 Defers To The Distributional Rules of "Insolvency Proceedings" Such As This Receivership
Although the SECO Intervenors' U.C.C. claim is based on Part 5 of Section 8, they are not entirely consistent with respect to the issue of the applicability of Part 5 to their relationship with Credit Bancorp. At one point they base their claim on the premise that they are holders of securities entitlements and Credit Bancorp was a securities intermediary. See SECO Mem. Partial Summary J. at 10-13. At another point they aver that it is the Receiver who views Credit Bancorp as a securities intermediary, and question that characterization. See SECO Reply Mem. at 13. 1n any event, Credit Bancorp is deemed to be a securities intermediary within the meaning of the U.C.C.
The SECO Intervenors contend that their rights to recover their stock are governed by U.C.C. § 8-503. This provision describes the property interest of securities entitlement holders with respect to financial assets held by their securities intermediaries, see U.C.C. § 8-503(a), and sets forth a general distributional rule regarding an entitlement holder's property interest as against a securities intermediary, see U.C.C. § 8-503(b). However, in "insolvency proceedings" this general rule does not apply and, instead, the applicable "insolvency law" governs:
Although this section describes the property interest of entitlement holders held by the intermediary, it does not necessarily determine how property held by a failed intermediary will be distributed in insolvency proceedings. If the intermediary fails and its affairs are being administered in an insolvency proceeding, the applicable law governs how the various parties having claims against the firm are treated. For example, the distributional rules for stockbroker proceedings under the Bankruptcy Code and Securities Investor Protection ACT ("SIPA") provide that all customer property is distributed pro rata among all customers in proportion to the dollar value of their total positions, rather than dividing the property on an issue by issue basis. For intermediaries that are not subject to the Bankruptcy Code and SIPA, other insolvency law would determine what distributional rule is applied.
U.C.C. § 8-503 Official Comment 1; see also U.C.C. § 8-503 Official Comment 2 ("If the intermediary is in insolvency proceedings and can no longer perform in accordance with the ordinary Part 5 rules, the applicable insolvency law will determine how the intermediary's assets are to be distributed."); cf. U.C.C. § 8-502 Official Comment 4 ("Although this section [8-502] protects entitlement holders against adverse claims, it does not protect them against the risk that their securities intermediary will not have sufficient financial assets to satisfy the claims of all its entitlement holders. . . . Unless other insolvency law establishes a different distributional rule . . . [the claimants] share . . . pro rata.").
An "insolvency proceeding" is "any assignment for the benefit of creditors or other proceedings intended to liquidate or rehabilitate the estate of the person involved." U.C.C. § 1-201(22). The Receiver was appointed to among other things take control of all of Credit Bancorp's affairs, marshal its assets, and maximize the value of the receivership estate. See Order Appointing Receiver ¶ 1. The scope of the Receiver's authority and the purposes for which he was appointed bring this proceeding within the meaning of "other proceedings intended to liquidate or rehabilitate the estate." U.C.C. § 1-201(22).
The case law concerning the meaning of "insolvency proceedings" under the U.C.C., while quite limited, supports this interpretation. See In re Cimmarron Nursing Ctr., 143 B.R. 578, 580 (Bankr. W.D. Okla. 1992) (stating that "[t]he few courts which have decided the issue have found that receiverships instituted to liquidate or rehabilitate a person's entire estate are insolvency proceedings [for purposes of U.C.C. § 1-201(22)]," but holding that receivership at issue was not such a proceeding because receiver did not have authority to liquidate or rehabilitate debtor's entire estate); In re Charter First Mortgage. Inc., 56 B.R. 838, 849 (Bankr. D. Or. 1985) (construing Oregon version of U.C.C. § 1-201(22) to include receiverships instituted under state law because "[t]he definitional language is certainly too broad . . . to conclude insolvency proceedings under the statute are limited to bankruptcy proceedings"); Frank Z Chevrolet Co. v. Miami Litho. Inc., 1975 WL 22839 (Ohio Ct. C.P. Montgomery Cty. Feb. 21, 1975) (appointment of receiver is "by definition" institution of "insolvency proceedings" under U.C.C. 1-201(22)); see also Maxl Sales Co. v. Critiques, Inc., 796 F.2d 1293, 1300 n. 9 (10th Cir. 1986) (stating in dicta that "insolvency proceedings" under Kansas version of U.C.C. § 102-1(22) is not restricted to federal bankruptcy proceedings).
The SECO Intervenors object that to characterize these proceedings as an "insolvency proceeding" runs afoul of the Second Circuit's admonition that equity receiverships should not be used as a substitute for the liquidation of a failed corporation through bankruptcy proceedings. See SEC v. American Board of Trade, 830 F.2d 431, 435-36 (2d Cir. 1987). This argument confuses the question of the meaning of a term of art employed by the U.C.C. with the question of whether the instant receivership has taken on an improper scope. The latter issue is discussed later in this opinion. See Part II.B.1., infra.
First, the definition of "insolvency proceedings" under the U.C.C. does not by its terms require that a corporation be "insolvent." Nor has the Receiver represented that Credit Bancorp is "insolvent." Second, there is more than one definition of the term "insolvent," including but not limited to the one set forth in the Bankruptcy Code. See 11 U.S.C. § 101(32). Third, the meaning of "insolvency proceedings" includes more than proceedings to effect the liquidation of a failed entity's estate. See U.C.C. § 8-503 ("proceedings to liquidate or rehabilitate"); cf. In re Conklin's Inc., 14 B.R. 318, 320 (Bankr. D.S.C. 1981) (Chapter XI proceeding to reorganize debtor's estate was "insolvency proceeding" under U.C.C. § 1-201(22) because that phrase includes proceedings to rehabilitate estates as well as to liquidate them) (citation omitted).
The SECO Intervenors also object that appointment of the Receiver is not an "assignment for the benefit of creditors." See SECO Reply Mem. at 14. Even if this were correct, an "insolvency proceeding" under the U.C.C. is not limited to an assignment for the benefit of creditors.
Therefore, appointment of the Receiver brought these proceedings within the meaning of "insolvency proceedings" under the U.C.C. Consequently, "the applicable insolvency law governs how the various parties having claims against the firm are treated." U.C.C. § 8-503 Official Comment 1. The law governing the distribution of assets to defrauded investors in a federal receivership is articulated in Elliot, 953 F.3d 1560, Durham, 86 F.3d 70, Topworth, 205 F.3d 1107, Real Property, 89 F.3d 551, andVanguard, 6 F.3d 222. Under this case law, equitable principles control, and the SECO Intervenors have not shown that they are entitled to summary judgment on their claim to recover their securities.
2. The SECO Intervenors Are Not Entitled To Summary Judgment Under The Law of Bailment
a. Revised Article 8 Supplants The Common Law of Bailment With Respect To The SECO Intervenors' Claims
The SECO Intervenors characterize their transactions with Credit Bancorp as involving the delivery of securities for the purpose of securing future loans or advances. Based on this characterization, they contend that their relationship with Credit Bancorp was that of bailor and bailee, or pledgor and pledgee. Therefore, they argue, they are entitled under the common law of bailment to recover the securities they transferred to Credit Bancorp because a bailor acquires only a possessory interests in the property pledged, while the bailee retains legal and equitable title. See SECO Int. Mem. at 7-10.
SECO, of course, did not retain legal title. See SECO CFA Art. IV § 4.2
Under Revised Article 8 of the U.C.C., however, the property rights of securities entitlements holders over assets held by securities intermediaries are defined by Article 8 rather than by common law:
Although this section [8-503] recognizes that the entitlement holders of a securities intermediary have a property interest in the financial assets held by the intermediary, the incidents of this property interest are established by the rules of Article 8, not by common law property concepts.
U.C.C. § 8-503 Official Comment 2.
This approach is consistent with the goal of Article 8 overall, which is explained in the Commentary addressing the article as whole:
The principal goal of the Article 8 revision project is to provide a satisfactory framework for analysis of the indirect holding system. The technique used in Revised Article 8 is to acknowledge explicitly that the relationship between a securities intermediary and its entitlement holders is sui generis, and to state the applicable commercial law rules directly, rather than by inference from a categorization of the relationship based on legal concepts of a different era.
American Law Institute and National Conference of Commissions on Uniform State Laws, Revised Article 8: Investment Securities, at 14 (1994.)
Revised Article 8 identifies and sets forth the rules which govern enforcement of an entitlement holder's property interest as against its securities intermediary, and specifies that these are the "only" mechanism for enforcement of those rights:
An entitlement holder's property interest with respect to a particular financial asset . . . [held by the securities intermediary] may be enforced against the securities intermediary only by exercise of the entitlement holder's rights under Sections 8-505 through 8-508.
Section 8-503(a) describes the property interest of an entitlement holder vis-a-vis a securities intermediary with respect to a financial asset held by the securities intermediary.
U.C.C. 8-503(c) (emphasis added).
Sections 8-505 through 8-508 concern an entitlement holder's right to receive payments and dividends, see U.C.C. § 8-505, to vote the stock, see U.C.C. § 8-506, to direct disposition, see U.C.C. § 8-507, and to change the forms of security entitlement, see U.C.C. § 8-508.
The Official Comments reiterate that Sections 8-505 through 8-508 are the "only" provisions by which an entitlement holder can enforce its property rights against its securities intermediary. See U.C.C. 8-503 Official Comment 2. The Comments also specify the circumstances under which those rules do not apply, namely, where "the intermediary is in insolvency proceedings and can no longer perform in accordance with the ordinary Part 5 rules." See id. In that situation, "the applicable insolvency law will determine how the intermediary's assets are to be distributed." See id. As previously explained, the applicable insolvency law in the instant case is the law governing the distribution of assets in a federal equity receivership. Therefore, application of the common law of bailment to the SECO Intervenors' claims as against Credit Bancorp has no place under the scheme set forth by the U.C.C.
This conclusion is not based on any assumption that Article 8 completely supplants the common law as it pertains to the relationship between securities intermediaries and their customers. See U.C.C. § 8-509 Official Comment ("This Article is not a comprehensive statement of the law governing the relationship between securities intermediaries and their customers. Most of the law governing that relationship is the common law of contract and agency, supplemented or supplanted by regulatory law."). Where, as here, the U.C.C. states specifically that an entitlement holder's property rights over assets held by its securities intermediary are defined by the U.C.C. and not by the common law, and specific U.C.C. provisions are identified as the "only" mechanism for enforcing those rights, then the common law has been supplanted.
The SECO Intervenors contend that Section 8-502, entitled "Assertion of Adverse Claim against Entitlement Holder," entitles them to assert a common law property claim against Credit Bancorp with respect to the Vintage and Titan stock. Section 8-502 provides:
An action based on an adverse claim to a financial asset, whether framed in conversion, replevin, constructive trust, equitable lien, or other theory, may not be asserted against a person who acquires a security entitlement under Section 8-501 for value and without notice of the adverse claim.
U.C.C. § 8-502.
Section 8-502 precludes common law property claims from being brought against bona fide purchasers of securities entitlements, i.e., those who acquire an entitlement for value and without notice of an adverse claim. The SECO Intervenors aver that Credit Bancorp was not a bona fide purchaser of their securities entitlements, since it obviously had notice of an adverse claim, and therefore that Section 8-502 permits them to bring such claims.
However, as explained above, the property rights of a securities entitlement holder against its securities intermediary are governed exclusively by Sections 8-503 to 8-508, not by Section 8-502.See U.C.C. § 8-503(c). Although a securities intermediary can also be a holder of securities entitlements, the terms "securities intermediary" and "purchaser of a securities entitlement" are not used interchangeably in the U.C.C. See, e.g., U.C.C. §§ 8-503(d) and (e). Nor do any of the examples provided in the commentary to Section 8-502 concern a claim by an entitlement holder against its securities intermediary regarding the entitlement holder's property rights in assets held by the intermediary. See U.C.C. 8-502, Official Comment 3, Exs. 1-4. Therefore, Section 8-502 is inapposite.
b. The Law of Bailment Does Not Support The SECO Intervenors' Claim
Finally, even if the SECO Intervenors' rights under the law of bailment and pledge were not supplanted by Revised Article 8 of the U.C.C., based on the evidence it cannot be concluded as matter of law that their transfer of securities to Credit Bancorp was a bailment or pledge.
A bailment is a "delivery of personal property for some particular purpose . . . upon a contract, express or implied, that after the purpose has been fulfilled it shall be redelivered to the person who delivered it." In re Veon, 12 B.R. 186, 189 (Bankr. W.D. Pa. 1981) (internal citation and quotation marks omitted); see Jones v. Hanna, 814 S.W.2d 287, 289 (Ky.App. 1991). A pledge is a "transfer, bailment or deposit of personal property as security for a debt." 72 C.J.S. Pledges § 3 (1987). Thus, a pledge is a special form of a bailment in connection with a debt. Securities are a form of personal property which can be pledged as security for a loan. See Provost v. United States, 269 U.S. 443, 454 (1926) (internal citations omitted).
The SECO Intervenors claim that their delivery of securities to Credit Bancorp was a bailment because it was for the sole purpose of securing future loans or advances through a secured credit facility. See SECO Mem. Supp. Partial Summary J. at 9. There is substantial evidence to the contrary. Credit Bancorp solicited customers by describing the "insured credit facility" as an investment vehicle through which Credit Bancorp was able to generate revenue from "riskless arbitrage" through major European banks. Moreover, the agreements executed by the SECO Intervenors were not limited to establishing a credit facility. They also provided that the SECO Intervenors would receive "dividends" on a quarterly basis. Neither SECO nor Ray availed themselves of the opportunity to draw down upon the credit facility. Both SECO and Ray did, however, receive dividend payments. Thus, there is at the very least a genuine dispute of material fact as to whether the SECO Intervenors were only involved in a loan arrangement rather than in what they viewed as an investment opportunity. Therefore, they are not entitled to summary judgment under the law of bailment.
SECO's claim under the law of bailment is further undermined by the fact that it transferred legal title over the Vintage stock to Brandon.See SECO CFA Art IV § 4.2. "In a bailment relationship, title to the property remains in the bailor." Veon, 12 B.R. at 189; see also Sturm v. Boker, 150 U.S. 312, 329 (1893) (in a bailment contract, "the title to the property is not changed"); Cornelius v. Berinstein, 50 N.Y.S.2d 186, 188 (N.Y.Sup.Ct. 1944) (in a bailment "the bailor retains the general ownership"). Although the agreement provided that title was to be transferred to Brandon, ostensibly in his role as Trustee, rather than to Credit Bancorp, the fact that SECO was to transfer title to someone else as part of the transaction is wholly inconsistent with the law of bailments.
Moreover, SECO, as well as Ray, actually delivered its assets directly to Credit Bancorp by wiring them into accounts for the benefit of, or for further credit to, Credit Bancorp.
Therefore, even if the U.C.C. did not abrogate the SECO Intervenors' right to assert a claim under the law of bailment and pledge, they would not be entitled to summary judgment on the basis of that law.
E. Bankruptcy
The SECO Intervenors contend that they would be entitled to recover their securities in a bankruptcy proceeding. This argument is premised on the theory that Credit Bancorp acted as a bailee as regards the securities and, therefore, that bankruptcy law would call for them to be returned to the bailees, i.e., the SECO Intervenors. As just explained, however, the SECO Intervenors have not shown that their relationship with Credit Bancorp was a bailor-bailee relationship. Therefore, for that reason alone the analogy they draw to bankruptcy law is not persuasive.
The Receiver has also pointed to authority for the proposition that a Credit Bancorp bankruptcy would constitute a "stockbroker liquidation," and that in that type of proceeding tracing of securities not held in the customers' own names, as here, would be disallowed. See 11 U.S.C. § 741-752 (stockbroker liquidation provisions); In re Baker Getty Fin. Servs., Inc., 106 F.3d 1255, 1259 1260-61 (6th Cir. 1997) (stockbroker liquidation provisions applied to entity which operated Ponzi scheme); but see Wider v. Wootton, 907 F.2d 570, 572 (5th Cir. 1990) (stockbroker liquidation provisions did not apply because operator of Ponzi scheme not deemed to be stockbroker within meaning of Bankruptcy Code). Although that authority is noted, no conclusion is drawn herein as to what would be the appropriate distribution scheme in a bankruptcy. The case law and statutory authority already discussed establish that the SECO Intervenors' motion for summary judgment should be denied. Therefore, further exploration of what might occur in a bankruptcy is not necessary.
II. The Compromise Plan Is Approved
The SEC has moved for approval of a partial plan of distribution and the SEC, certain intervenors, and the Receiver have submitted proposed distribution plans. There are four proposed plans in all.
The case law reveals, if not a clearly defined methodology, at least a general approach for determining whether to approve a distribution to fraud victims of assets held in a federal equity receivership, and how such a distribution should operate. That approach involves making findings of fact and drawing conclusions of law based upon the equitable principles which govern such receiverships. See, e.g., Durham, 86 F.3d at 73 (discussing district court's consideration of evidence as to scheme and conclusion as to appropriate distribution plan under principles of equity); P.B. Ventures, 1991 WL 269982 (making findings of fact as to workings of fraudulent scheme and conclusions of law as to how receivership assets should be distributed to victims); SEC v. Elliott, No. 87 Civ. 1212, 1989 WL 50550 (S.D. Fla. April 29, 1989) (adopting Receiver's finding of fact and making conclusions of law as to appropriate distribution), aff'd in part, vacated in Part on other grounds, rev'd in Part on other grounds, 953 F.2d 1560 (11th Cir. 1992), and vacated in Part on other grounds, 998 F.2d 922 (11th Cir. 1993). This is the approach followed herein, based upon the facts found above.
In addition, the Court has benefitted from numerous written submissions regarding the merits of each of the proposed plans, including from the SEC, the customers (both intervenors and non-intervenors), and certain broker-dealers. Finally, oral argument was heard regarding the plans on several different hearing dates as set forth above.
A. A Partial Distribution Is An Appropriate Equitable Remedy At This Time
The SEC has proposed a partial distribution in order to further the goal of the disgorgement remedy of depriving the wrongdoer of his ill-gotten gains. See SEC v. Wang, 944 F.2d 80, 85 (2d Cir. 1991) (citations omitted); see also Partial Consent Judgment. The SEC further recommends that the distribution be partial because the Receiver has not yet been able to marshal and bring under his control all Credit Bancorp assets. Thus, the SEC maintains that neither the final amount of disgorgement nor the appropriateness of a civil penalty can be calculated at this time.
The Credit Bancorp customers, for their part, urge that a distribution be approved forthwith in order that they may begin to recoup the losses they suffered by way of Credit Bancorp's fraudulent scheme. Although the customers differ greatly as to what they believe to be the appropriate distribution plan, they share the SEC's view that at present the distribution should be partial, leaving open the possibility of additional distributions if and when additional assets become available.
This Court has broad discretion to fashion an appropriate equitable remedy in this SEC enforcement action. See SEC v. Certain Unknown Purchasers of Common Stock of and Call Options for the Common Stock Santa Fe Int'l Corp., 817 F.2d 1018, 1020 (2d Cir. 1987); SEC v. Safety Fin. Serv., Inc., 674 F.2d 368, 372 (5th Cir. 1982); SEC v. Lincoln Thrift Assoc., 577 F.2d 600, 606 (9th Cir. 1978); SEC v. Arkansas Loan Thrift, 427 F.2d 1171, 1172 (8th Cir. 1970). Distribution to the victims of a fraudulent scheme of funds obtained through the disgorgement of the defrauder's ill-gotten gains, like the appointment of a receiver, is an appropriate form of equitable relief in such an action. See, e.g., Real Property, 89 F.3d at 553; Unknown Purchasers, 817 F.2d at 1021.
There is another issue, however, which is the Second Circuit's admonition in American Board of Trade, 830 F.2d 431, that an equity receivership should not be employed as a substitute for a bankruptcy proceeding to effectuate the liquidation of a defendant firm. The SEC maintains that it is mindful of this admonition and has expressed the view that its proposed partial distribution does not entail a complete liquidation and does not run afoul of this decision. The SEC further avers, however, that if the Court determines that the consequence of any plan adopted would result in the effective total liquidation of Credit Bancorp then the Court should consider placing Credit Bancorp into bankruptcy. The Receiver has also noted his awareness of this issue. See Letter from Loewenson to the Court of 4/11/00. The Receiver has thus far declined to seek the initiation of bankruptcy proceedings, in large part because it has been apparent that the customers have not wished for that to occur, at least at this juncture. See id. The customers, for their part, have not petitioned for Credit Bancorp to be placed into bankruptcy.
The SEC has declined to express a view as to whether any of the other plans would result in an effective total liquidation. Insofar as the plans essentially involve different ways of slicing up the same asset pie while at the same time presuming that there are additional assets not yet under the Receiver's control, there is no material difference among them in this regard. In other words, it appears that if any of the plans runs afoul of American Board of Trade, 830 F.2d 431, they all do.
The SECO Intervenors have opposed the SEC Plan in part on the ground that they would fare better in bankruptcy proceedings. However, they have declined to take any action to have bankruptcy proceedings instituted.
This issue is without doubt quite complex, and is a matter of no little concern for this Court. However, given that neither the Receiver nor, more importantly, the defrauded customers, have sought the initiation of bankruptcy proceedings, given the SEC's position, and given that the contemplated distribution is partial in nature, the Court will decline to exercise its inherent power to place this matter into bankruptcy at this juncture.
The customers have the right to petition for bankruptcy. See generally, Charles Alan Wright and Arthur P. Miller, 5 Federal Practice and Procedure § 1229 (2d ed. 1990). In addition, the Receiver has the power to place Credit Bancorp into bankruptcy pursuant to the order appointing him. See Order Appointing Receiver Art. I(h). The SEC does not have such rights or powers.
The proposed distribution plans differ in a number of ways as to how they measure customers' claims for purposes of a distribution plan, including but not limited to the date by which they value claims of customers who deposited securities. Thus, the return to any particular customer could vary substantially among the various proposed plans and theories of equitable distribution. However, customers who deposited securities with Credit Bancorp and whose securities are still extant have expressed a strong desire for the return of those securities rather than cash payments obtained through the liquidation of the assets held by the Receiver.
The Receiver reports that, due to the limited liquidity of a substantial portion of the securities held by the Receiver, the sale of a substantial amount of securities in Credit Bancorp accounts would not realize the current market value of those securities as reflected in their published share prices. The Receiver has expressed a strong preference to limit the market risk reflected in the current holdings of the receivership by replacing those holdings with cash or United States Government backed securities.
A partial distribution of the Credit Bancorp assets will serve the twin purposes of depriving Credit Bancorp of its ill-gotten gains and providing some relief for the defrauded Credit Bancorp investors. The SEC has moved for a partial distribution and the Credit Bancorp customers, while they differ as to the type of plan they prefer, halve been unanimous in supporting a distribution as soon as possible. Therefore, pursuant to this Court's equitable powers, it is appropriate that a partial distribution of the Credit Bancorp assets be approved.
Time is also, as always, a critical element in determining the propriety of a partial distribution. While the asset freeze has stopped the looting by Blech, it has caused severe hardship to many investors, particularly those who entrusted virtually all of their assets to Credit Bancorp. Larger customers recognize the possibility of substantial market risk. All customers who have been heard in these proceedings have from the outset sought a speedy resolution.
B. The Principles Governing The Choice of A Distribution Plan
As discussed in connection with the SECO Intervenors' motion for partial summary judgment, the fundamental principle governing adoption of a distribution plan is that it should be equitable and fair, with similarly-situated investors treated alike. See Elliott, 953 F.2d at 1569; Durham, 86 F.3d at 73; Vanguard, 6 F.3d at 226-27. What is equitable and fair will depend on the circumstances. Thus, courts have approved different types of plans in different situations. Compare. e.g., Durham, 205 F.3d at 73 (approving pro rata distribution of receivership cash assets even though most of those assets were traceable to specific claimants) with. e.g., P.B. Ventures, 1991 WL 269982, at *2-*3 (approving customer recovery of shares through tracing). In equity, remedies to which claimants might be entitled to under other law may be suspended if such a measure is consistent with treating all claimants fairly. See Vanguard, 6 F.3d at 226 ("[E]ven if entitlement [to trace assets] under state law could be established, that wouldn't end the matter in this federal receivership."); Elliott, 953 F.2d at 1569 (disallowing tracing on equitable grounds although such remedy would have been available as contract remedy).
Of course, where the assets of the receivership estate are insufficient to afford full recovery to all victims, any given plan is likely be viewed more favorably by certain victims than others depending on how they fare under that plan. See, e.g., Elliott, 953 F.2d at 1569 (defrauded investors whose assets were traceable preferred application of tracing method over pro rata approach, as tracing would have garnered them 100% recovery). An equitable plan is not necessarily a plan that everyone will like. Certainly, this is a case in point.
C. The Proposed Plans For Partial Distribution
There are four proposed plans of partial distribution before the Court. The essential elements of each plan are set forth below.
The SEC initially took the position that the Intervenors lack "standing" to propose a plan of distribution. Although the SEC never explicitly abandoned that position it has not continued to press this view. In any case, given that the SEC has proposed a distribution plan it is appropriate to consider the customers' views. Even if there might be standing issues if the SEC had not proposed a partial distribution, under these circumstances the Stappas and SECO Plans are appropriately treated as elaborate customer comments.
1. The SEC Plan
There are four claim classifications, to be paid in the following order of priority:
(1) receivership administrative expenses;
(2) tax claims;
(3) margin or other loans held by banks, broker-dealers, or other financial institutions at which Credit Bancorp maintained accounts and which contain customer deposited securities;
(4) customer claims.
The Receiver is to pay all secured margin debt as soon as practicable after the approval order.
The receivership assets available for customer claims are distributed on a pro rata basis. No class of customers is accorded priority over any other class. Customers are not permitted to trace assets, i.e., to recover assets identifiable as having been deposited by that customer to the extent to which those assets are still in existence.
Each investor's claim is valued as of the date the investor deposited its assets with Credit Bancorp. In order to make this valuation, reference would be made to the records generated by Credit Bancorp at that time. Credit Bancorp generated these records in order to calculate the prepaid dividend paid to the customers. Thus, these records reflect the value of each investor's assets at the time of deposit.
A "net investment" method is used, pursuant to which a customer's claim is limited to the principal balance deposited with Credit Bancorp and is reduced by the amount of any funds previously received including prepaid or quarterly custodial dividends, loans, or other distributions. In addition, customers may not assert claims for interest, dividends, or promised returns.
Investors may elect to receive a distribution in cash or, if the customer's deposit was in the form of securities and if the Receiver is in possession of such securities, in the form of stock. A customer who elects to receive a distribution in the form of stock is limited to the number of shares that customer deposited with Credit Bancorp. Since the distribution is pro rata, the amount of the total distribution to which a given customer is entitled is based on the proportion represented by the customer's claim (valued as of the date of investment) as compared to the total funds available for distribution.
2. The Stappas Plan
The Stappas Plan, as the Stappas Intervenors themselves point out, has much in common with the SEC plan. Specifically, like the SEC plan, the Stappas Plan: (1) rejects tracing of specific assets in favor of a pro rata distribution; (2) requires margin balances to be liquidated as soon as practicable; (3) permits customers to elect to receive distributions in kind, but only up to the amount of their allowed claims; and (4) prioritizes customer claims over claims by general creditors.
The Stappas Plan differs from the SEC Plan as to the following key elements:
Investors' claims are valued as of either November 17, 1999, the date of the entry of the temporary restraining order in this case, or November 23, 1999, the date of the asset freeze order. The basis for this valuation is the value of the customer's "portfolio" as reflected on the October 31, 2000 customer statements, which were the last monthly statements issued by Credit Bancorp before the asset freeze. The Receiver is to calculate the value of the assets reflected in each customer's account statement as of the valuation date.
At one time the Stappas Intervenors proposed that customers who executed a CFA were entitled to priority over the Bob Mann customers. The Stappas Intervenors have recently changed their position on that issue, and no longer seek such priority. See Letter from Sheldon Weiss ("Weiss"), on behalf of the Stappas Intervenors to the Court of November 1, 2000, at 6 n. 11.
The Receiver has retained the accounting firm of KPMG to assist in the valuation of customers' claims. KPMG has created a database program which enables it to calculate the value of a particular "portfolio" as of a given date.
The Stappas Intervenors recognize that some customers' assets had been wholly or partially consumed by Credit Bancorp, and/or encumbered with margin debt, as of the asset freeze November, 1999, and that the customer account, statements did not reflect these facts. Under the Stappas Plan, the investors' portfolios are valued as if the assets reflected in the most recent account statements did exist and were not encumbered.
Claims are not reduced by the amount of any funds received by customers in the form of prepaid or quarterly custodial dividends, loans, or any other distributions previously made to the customers by Credit Bancorp.
3. The SECO Plan
The SECO Plan is different in kind from both the SEC and Stappas Plans in that it provides for investors who deposited securities to recover those securities through tracing, subject only to any valid margin liens by the brokerage houses. This would be accomplished by imposing a constructive trust in favor of the customers over the stock deposited with Credit Bancorp.
The SECO Plan prioritizes customers who executed a Credit Facility Agreement or similar document over the Bob Mann customers by permitting those customers to recover their securities through tracing, subject only to any valid margin liens. Cash customers would obtain a return only if and when stock customers' claims had been satisfied. Moreover, the cash investors' claims are offset by all funds received by those investors, whether characterized as dividends, interest, loans, or return on investment or principal. Stock investors' claims, by contrast, are offset only by prepaid or quarterly custodial dividends and not by any other distributions attributable to the deposited security. In addition, the expenses for the Receiver and the Margined Stock Claimants Committee, described below, are to be paid from the available cash — namely, the same pool of cash to be used to pay the Bob Mann customers.
The Receiver's fees are limited to $2 million.
A Margined Stock Claimants Committee is to be formed to resolve the margin loans held by Credit Bancorp's depository institutions. This committee is to be composed of representatives of SECO, Ray, Praegitzer, and such other stock claimants as wish to participate. This committee is empowered to investigate margin liens, seek release of margined stock, and undertake litigation regarding those liens. Expenses for these activities would be paid out of the receivership assets. In the event a customer who seeks to trace his stock is subject to a valid lien, the committee would determine whether to authorize the Receiver to sell enough stock to satisfy the lien or to pay the customer in cash.
4. The Compromise Plan
The Compromise Plan was formulated by the Receiver in an attempt to craft a compromise from among the competing proposals previously submitted to the Court.
Adoption of the label "compromise plan" is not intended to imply that all the customers agree with this characterization. On this point, as on so many others, the customers have expressed a wide range of views. Thus, some customers object that the Receiver's formulation "in no way represents a compromise," Letter from Weiss on behalf of the Stappas Intervenors of November 1, 2000, at 2, while others observe that "[t]he Compromise Plan is the only proposal that makes any attempt to reconcile the divergent interests of identifiable asset customers with the interests of cash customers and customers whose securities were liquidated," Letter from Michael Chertoff on behalf of Norman and Marie Sevell of November 2, 2000, at 2.
The central premise of the Compromise Plan is that it provides a mechanism for returning securities to investors who seek such recovery, where the securities are extant and within the Receiver's control, while at the same time generating funds to be used for distribution to the remaining customers and for other needs of the Receivership.
More specifically, under the Compromise Plan, customers who seek to recover their securities are to pay into the receivership an "Undertaking" equal to a percentage of the current market value, essentially, of the shares attributable to them at the time of the plan's implementation, plus the sum of all custodial dividends and loans, plus interest, received from Credit Bancorp. The Undertaking percentage is estimated to be approximately 25.5%, although that number could change due to market fluctuations or changed needs of the Receivership. In return for the Undertaking payments, customers recover their shares.
The Receiver uses the term "designated market value," which is the value of the shares claimed by a particular customer based on the average closing price of each security deposited for the five trading days preceding the distribution of the initial notice to customers regarding implementation of the distribution.
Some customers, in particular the smaller ones, might have trouble raising the cash necessary to make the Undertaking payment. See Letter from Sally Fraser to the Court of October 31, 2000 (questioning how she is to raise funds to make Undertaking payment). The plan allows for the Undertaking to be made by relinquishing the customer's claim to the number of shares representing the value of the Undertaking payment. See Compromise Plan ¶ G.
Customers whose securities were sold by Credit Bancorp — and thus cannot recover their stock in the manner described above — and customers who deposited cash will receive a cash distribution from among the funds held by the Receiver once the Receiver has received the Undertaking payments. The amount of the cash distribution for customers who deposited stock will be, in essence, the amount equal to the current market value of the stocks deposited minus the Undertaking percentage and the sum of any custodial dividends and loans, with interest. The amount of the distribution for customers who deposited cash will be, in essence, the amount equal to the cash deposited minus the Undertaking percentage. The claim of intervenor Robert Praegitzer ("Praegitzer") is to be treated like the claim of a cash investor.
The Compromise Plan contemplates a second, supplemental distribution once the assets held overseas are brought under the Receiver's control. The methodology would be similar to that employed for the initial distribution. That is, investors who wish to recover their securities would pay the appropriate Undertaking, as set forth above, in return for which they would recover those securities. After receiving these Undertakings, there is a supplemental distribution to those customers who deposited stocks and the total value of whose claims has appreciated less than ten percent since the date of the TRO, November 17, 1999. This distribution applies whether or not the customers' stocks were sold by Credit Bancorp. There is also a supplemental distribution to customers who deposited cash. The customers receiving the supplemental distribution, if they have not previously paid an Undertaking, are to pay the sum of all custodial dividends and any loans, with interest.
Finally, after the supplemental distribution just described, the Compromise Plan contemplates a further distribution in the form of "depreciation adjustment" payments to investors the value of whose claims have depreciated since November 17, 1999.
The Receiver has structured the Compromise Plan so that there will be sufficient revenue, based on revenues generated through the plan itself and the funds currently held by the Receiver, to provide for the expenses of the receivership, including the distributions to customers, administrative expenses, and the margin loans. See 11/6/00 Receiver Decl. The one expense which is not addressed by this plan is the potential tax liability of Credit Bancorp. That issue is the subject of a motion by the Receiver, which motion will be heard and resolved in the near future.
An overhanging issue threatening the Compromise Plan is the resolution of the margin debt which Credit Bancorp secured by pledging certain securities. There are nine margin accounts at eight financial institutions. The total margin debt is approximately $30 million, and the interest expense on this debt is approximately $200,000 per month.
Several of the financial institutions with which Credit Bancorp maintained margin accounts, namely, Ameritrade, Inc. ("Ameritrade"), Deutsche Bank Securities, Inc. and DB Alex, Brown LLC (collectively,. "Deutsche Bank"), Chase Investment Services Corp. ("CISC"), Charles Schwab Co., Inc. ("Schwab") and Legg Mason Wood walker, Inc. ("Legg Mason") (collectively, the "broker-dealers"), have objected to the Compromise Plan. Ameritrade is an intervening party to this action. Deutsche Bank has moved to intervene, which motion has been opposed by the SEC. Deutsche Bank will be granted permission to intervene pursuant to Federal Rule of Civil Procedure 24(b), for the reasons set forth in connection with the granting of motion by Ameritrade to intervene. The other institutions are non-parties and have not sought to intervene at this juncture.
CISC represents that Credit Bancorp entered into a margin lending agreement with CISC's clearing broker, National Financial Services Corporation ("NFSC") rather than with CISC, but that in the event of a default NFSC is entitled to indemnification by CISC. Therefore, CISC maintains that it has standing to assert objections relating to this matter. CISC further represents that NFSC:joins in its opposition. No objection has been raised on the ground of standing to CISC's submission.
Essentially, the broker-dealers contend that the Compromise Plan does not sufficiently protect their security interests in the stock held in the Credit Bancorp accounts as collateral for margin loans taken out by Credit Bancorp. The broker-dealers urge the Court to require that all margin debt claims be resolved prior to any customer distribution, as proposed in the SEC Plan.
The Compromise Plan provides that the funds collected through the Undertaking payments will be held in escrow or in a special purpose bankruptcy-remote vehicle pending distribution of the shares, and that those funds will be released to the receivership simultaneously with the distribution of securities to each customers. See Compromise Plan ¶ H. The plan further states that. no margin debt will be repaid by the Receiver except upon application to the Court with notice of all parties. See id. ¶ O.
The broker-dealers contend that resolution of the margin debt issue prior to any customer distribution — indeed, prior even to approval of a plan — would provide greater certainty for the receivership and the customers because the margin debt is an important factor in determining the cash needs of the receivership estate. The broker-dealers also point out that the monthly accrual of interest is to the detriment of the customers. The Receiver proposes that implementation of a distribution plan and resolution of the validity of the security interests occur simultaneously because the choice of a distribution plan will determine how funds are to be raised to pay off any valid margin debt. None of the customers have expressed support for the broker-dealers' position.
The Compromise Plan generates these funds through the payment of Undertakings. The SEC and Stappas Plans generate them by liquidating securities held by the Receiver.
So long as adequate provisions are made to protect the broker-dealers' security interests, including non-parties as well as any intervenors, it is appropriate to approve a distribution plan and set it in motion simultaneously with the ongoing efforts to resolve the validity of the security interests and to make the appropriate debt payments. The Receiver is correct that it is necessary to choose a distribution plan in order to determine — and generate — the funds needed to satisfy those broker-dealer interests which are valid. It is also in the interests of the customers to proceed as expeditiously as possible with implementation of a distribution plan.
The broker-dealers contend that the legal issues concerning their asserted interests are quite narrow and that all necessary fact discovery has been completed, so that prompt resolution of this matter is possible. The Receiver objects that the legal issues are more complex than the broker-dealers characterize them, and that additional discovery is required. SECO, which has been conducting discovery in this matter in conjunction with the Receiver, concurs that additional discovery is required. SECO points to certain specific items it has sought which go to the issue of notice by the financial institutions of adverse claims to the securities held in its accounts.
There appears to be no dispute that the broker-dealers' security interests are governed by the terms of the margin agreement between Credit Bancorp and the given institution and by Article 8 of the U.C.C. More specifically, the critical issue is whether the institution had notice of adverse claims to the securities held in the Credit Bancorp accounts. See U.C.C. § 8-105. Absent further briefing of the issues, however, it would be premature to determine whether the broker-dealers or the Receiver have correctly defined the precise legal question to be answered. With respect to the progress of discovery, the Receiver and SECO have been proceeding as expeditiously as possible and there are grounds for continuing the discovery process at this time.
Indeed, as both the Receiver and SECO point out, SECO has every incentive to proceed with all due haste since it is funding much of the discovery effort and, as the largest customer, will be paying for the lion's share of any accrued margin interest.
The Receiver has proposed that, once the factual record is sufficient with respect to a particular financial institution, he will proceed by motion made separately with respect to each institution and notifying the institution that it is the subject of the motion as well as all parties to this proceeding. The Receiver has further proposed that this Court then conduct summary proceedings, in which proceedings the given institution will have an opportunity to be heard, to determine the validity of the institution's interest.
Procedures such as those proposed by the Receiver have been held to satisfy the requirements of procedural due process in adjudicating claims of both parties and non-parties to assets held in a federal equity receivership. See Topworth, 205 F.3d at 1113 (district court within its discretion to use summary proceedings initiated by order to show cause to resolve "claims of non-parties to property claimed by proceedings . . . so long as there is adequate notice and opportunity to be heard") (citation and internal quotation marks omitted); Elliott, 953 F.2d at 1567 (district court has discretion to use summary proceedings so long as parties provided notice and opportunity to be heard).
The broker-dealers contend that they have a constitutionally-protected property interest in the margined securities and that they cannot be forced to relinquish those securities in exchange for a "vague promise" that they will be reimbursed at an unspecified future time with an undetermined amount of cash. The broker-dealers contend that the Receiver seeks to transform them into mere unsecured creditors.
Under the Compromise Plan, the Receiver will provide cash collateral in lieu of the customer-deposited securities as security for any extant margin loans. This cash collateral would be deposited in escrow in an interest-bearing account with the financial institution pending resolution of outstanding matters with respect to the account, including any security interest asserted therein. The amount of cash collateral would equal the then-existing margin balance plus two years worth of interest. The Receiver has submitted a proposed order which includes a provision that:
The Receiver proposes to submit this order for approval by the Court at the appropriate juncture.
[t]he cash collateral shall be subject to a security interest to the same extent and upon the same terms and subject to the same claims and defenses as had the securities been deposited in the account and delivered to the Receiver consistent with this Order.
Finally, there would be ongoing supervision by the Court over the disposition of the cash collateral and the resolution of the margin debt.
The proposed order is sufficient to protect the broker-dealers' interests. The order preserves those claims and defenses they would have been able to assert based upon the deposited securities. Cf. Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 592 (1935) (finding "taking" of mortgage interest where it was replaced in part "with an otherwise unsecured promise to purchase at the end of the period for less than the appraised value")
Therefore, the Compromise Plan provides appropriate measures for addressing the issue of the security interests asserted in the stock held in the Credit Bancorp accounts.
D. Comparison of The Key Elements of The Plans
The SEC has expressed the view that both its plan and the Compromise Plan, while different from each other, further the goal of treating all Credit Bancorp investors in an equitable fashion. The customers have expressed varying views about each of the four plans presently before the Court.
1. It Would Be Inequitable To Draw Distinctions Based On The Type of Agreement Executed or Whether A Customer's Assets Are Traceable
The SECO Plan prioritizes customers who executed CFAs or equivalent documents, and whose securities are traceable, by permitting them to recover all of their traceable assets, while relegating customers whose stock is missing and customers who deposited cash or cash equivalents to recovery from a small cash reserve. The SECO Intervenors contend that this result is justified on both equitable and legal grounds.
Subject only to any valid margin liens.
With respect to the SECO Intervenors' legal argument, which was discussed at length in the resolution of their motion for summary judgment, it will be assumed arguendo that they have valid claims for relief that would entitle them to recover their securities through tracing under the law of contract, the U.C.C., and the law of bailment. Nevertheless, because equitable concerns may supersede such legal claims to relief, the tracing remedy will be disallowed unless they can show that it would be equitable.
The SECO Intervenors contend that their proposal is equitable because, first, they believe that as the largest investors they are "most at risk," and second, the contend that they were entitled to rely on the "trust" arrangement provided for in the CFAs and Trustee Letters. The Stappas Intervenors similarly contend that they were entitled to rely on their assets being safeguarded by the "trustee" arrangement set forth in those documents, whereas the agreement signed by the Bob Mann customers contained no such provision.
The views of the other customers who signed CFAs vary. Compare. e.g., E-mail from Jan Hoeffel to Andrew Fields of June 20, 2000 (Credit Facility Agreement customers' "accounts were thus represented and documented to have a higher level of assurance and safeguard than the [Bob Mann customer] accounts") with, e.g., E-mail from Clinton B. Owens to Andrew Fields of June 20, 2000 ("[W]hile I deposited stock equities supported by an insured credit facility, those who deposited cash no doubt thought they had the same protection as I did and should be given the same treatment as all other customers.")
First, with respect to the SECO Intervenors' contention that it is equitable to prioritize the largest investors because they have the most to lose in terms of a dollar amount, as mentioned earlier in this opinion that argument is contrary to equity. See n. 20, supra; see also SEC v. Forex Asset Mgmt., L.L.C., No. 99 Civ. 0256, slip op. at 12 n. 9 (N.D. Tex. Feb. 7, 2000) (fact that one fraud victim invested more money than others not "a reason to elevate their status above the other investors").
Second, the argument that CFA customers are more entitled to rely on the belief that they were not going to be defrauded is also contrary to equity. All of the Credit Bancorp customers entered into agreements which provided assurances regarding their assets. The CFA customers entered into agreements providing for a trustee. The Bob Mann customers received assurances that Credit Bancorp would act as a fiduciary in managing the investment of their cash. See 6/21/00 Receiver Decl. Exh. B; see also Conway v. Icahn Co., 16 F.3d 504, 510 (2d Cir. 1994) ("The relationship between a stockbroker and its customer is that of principal and agent and fiduciary in nature, according to New York law."). The trustee arrangement was merely one of many fictions perpetuated by Credit Bancorp.
If distinctions as to the reasonableness of the investors' reliance were to be drawn, then it would be appropriate to consider facts other than the type of agreement executed. For example, SECO encountered warning signs about the Credit Bancorp prior to making its investments, including the rather prescient view expressed by an individual with whom SECO's counsel consulted that "somewhere within this deal there is a trap door or, worst-case scenario, a glorified Ponzi scheme." See 6/28/00 Receiver Decl. Exh. 9 (letter from Samuel L. Ellis to Andrew M. Wolov of April 5, 1999); see also 6/28/00 Receiver Decl. Exhs. 8, 10, 11 (correspondence pertaining to SECO negotiations with Credit Bancorp and reflecting potential risks of the investment). In addition, the representations made to CFA customers were not the same across the board. For example, the Ray CFA failed to include any restriction on the hypothecation, pledge or margin of the Titan shares placed with Credit Bancorp. See Ray Decl. ¶ 2 and Exh. 1. In addition, the CFA customers, including the SECO Intervenors, handed over their assets in a manner that contravened the provisions of the CFA itself, namely, by wiring them directly to Credit Bancorp rather than delivering them to Brandon, the purported trustee.
Yet another issue would be the question of whether customers who took steps to remove restrictive legends from their stock certificates, such as Ray, have "unclean hands." See Letter from Jon, Karen, and Henry Greer to Andrew Fields of June 20, 2000 at 3 (advocating that customers who removed restrictive legends be accorded lower priority). This would be a relevant consideration in equity. See. e.g., Dunlop-McCullen v. Local 1-S. AFL-CIO-CLC, 145 F.3d 85, 90 (2d Cir. 1998) (discussing unclean hands doctrine)
The SECO Intervenors do not advocate inquiring into the reasonableness of each customer's reliance in light of all the relevant circumstances. Nor would that approach be constructive at this juncture. Rather, the better and more equitable approach is to recognize that all customers are similarly-situated in that they relied on assurances from Credit Bancorp and were defrauded. They are all innocent parties struggling over a limited res.
The one exception to this principle might be certain Credit Bancorp "insiders." This issue is discussed infra.
Thus, the SECO Plan draws unjustifiable and inequitable distinctions among customers. Moreover, under this plan the recovery of CFA customers with traceable stock would come at the direct expense of other Credit Bancorp victims.
By contrast, both the Compromise Plan and the SEC Plan are equitable in that they do not prioritize any one group of customers. The SEC Plan provides for a pro rata distribution that corresponds to the value of the customer's initial investment as a proportion of the total amount invested by all customers. As discussed at length earlier in this opinion, this methodology has been recognized as equitable in a number of cases such as this one, see. e.g., Real Property, 89 F.3d at 552-53;Elliott, 953 F.2d at 1569-70, and it would be so here. The Compromise Plan is also equitable in that it allows customers to recover their securities, where such recovery is possible, but also provides for a distribution to other customers. In addition, the plan provides for the same deductions from each customer's claim, namely: the Undertaking percentage plus the sum of all custodial dividends and loans, with interest.
Some customers have objected that the Compromise Plan is essentially indistinguishable from the SECO Plan and is therefore inequitable. See Letter from Armand Mele on behalf of Cole-Hatchard intervenors to Thomas Melton of 10/5/00, at 2. However, although the Compromise Plan permits customers with traceable stock to recover some of that stock — i.e., subject to the aforementioned deductions — unlike the SECO Plan it does not do so at the expense of other customers. Rather, the Compromise Plan recognizes the desire of many investors to have their securities returned while employing a method for such recovery that serves to raise funds for the receivership that can then be used to make distributions to other customers possible.
As between the SEC and the Compromise Plan, there is an additional factor which weighs in favor of the latter. This is the fact that the SEC Plan poses certain risks for the receivership in that it requires liquidation of substantial assets under the Receiver's control, including to pay off margin loans. The Receiver warns that due to the limited liquidity of a substantial portion of the securities in his possession, the sale of a substantial amount of the value of those securities would not realize their current market value of as reflected in the published share prices. Thus, although it is impossible to predict with any specificity what would be the effect of adopting the SEC Plan, it is likely that the total value of the Receivership assets would suffer. This would work to the detriment of all customers.
In addition, the Receiver has expressed the belief that allowing recovery of stock might avoid significant tax liabilities for customers that would be associated with large cash payments. Without more analysis of the complex issues involved, however, this is somewhat speculative.
This is not to say that the Compromise Plan is better for each and every customer than any of the other plans. On the contrary, each customer fares differently under each plan. It is to say, however, that the Compromise Plan is both equitable and has important practical advantages over the SEC Plan.
2. The Claim Valuation Date
The SEC, Stappas, and Compromise Plan each propose a different moment in time for valuation of the investors' claims. The SEC Plan uses the date of investment, the Stappas Plan uses the date of the TRO or asset freeze order, and the Compromise Plan uses what is essentially current market value.
The SECO Plan operates differently, since it provides for recovery through tracing without regard to the value of the securities traced, and is not relevant here.
Due to the fact that most of the assets held by the Receiver are in the form of securities, and the effect of movements in the market upon those assets, the choice of a valuation date has a significant impact on the worth of each customer's claim. Customers whose securities have increased in value since their initial deposit with Credit Bancorp benefit most from the adopting of a later valuation date, e.g., the asset freeze date or, depending on how the assets have fared in the market since that time, current market value. Conversely, customers whose securities have depreciated in value since their initial deposit benefit most under the SEC Plan.
Each customer would prefer, of course, to have the worth of this claim determined as of the moment when it is highest in value. The question, however, is what is equitable under all the circumstances given that different customers are affected differently by the choice of any given date.
The SEC Plan is based on the premise that Credit Bancorp's customers handed over control of their assets to Credit Bancorp as of the date of investment and, therefore, became similarly situated as of that date. Once the assets were under the control of Credit Bancorp, the argument goes, the status of each customer's portfolio, including the extent to which the assets were preserved and any investment decisions were the result of choices made by Credit Bancorp rather than the customer. In that sense, then, the total value of a customer's portfolio as of any date after the date of investment is essentially fortuitous.
The Stappas Plan, by contrast, is based on the premise that until this Court's asset freeze order the customers retained the ability to "investment-type decisions" regarding their assets, such as to borrow against the credit facility, to direct Credit Bancorp to purchase or sell specific securities, or to request that their securities be returned. Thus, the theory is that customers became similarly-situated as of the asset freeze and may rightfully benefit from market fluctuations in their favor up to that time, but should neither bear the brunt of negative market fluctuations nor reap the gains of positive ones since then. The Stappas Intervenors also contend that the group whose assets declined in value between the date of deposit and the date of the asset freeze includes a number of corporate "insiders" of privately held companies, and that it would be inequitable to adopt a plan that is more beneficial to such investors.
Here again there is a tension between the Stappas Intervenors' argument and their rejection of tracing. They reject tracing on the theory that all customers should be deemed to have lost control over their assets, albeit unwittingly, when they handed them over to Credit Bancorp.
The other customers have taken varying views on this point.Compare. e.g., Letter from Andrew and Regina Calcagno to Andrew Fields of June 19, 2000, at 1 (date of the asset freeze "is the date when we were absolutely prevented from exercising any control over our investments in the CBL program"); Letter from Paul M. Henderson to Andrew Fields, of June 23, 2000, at 1 ("The depositors had full access to their assets up until November 17, 1999.") with, e.g., Letter from Armand P. Mele on behalf of the Cole-Hatchard Intervenors to the Court of June 30, 2000, at 3 ("[W]hile claimants could theoretically make investment decisions concerning their assets, in reality those decisions were either ignored or effectuated at the expense of other victimized customers."); Letter from Jon Greer, Karen Greer, and Henry Greer of June 20, 2000 (customers lost control as of date of investment); Letter from Matthew J. Brief on behalf of the William Robert Fiaccone Trust of June 19, 2000 ("Some investors could have withdrawn assets by the date of the TRO but all the investors most certainly were lulled into a false sense of security and simply could not have received a return of their assets had they asked by the date of the TRO.").
They contrast, for example, the experience of Praegitzer, the founder of Praegitzer Industries and its majority shareholder, with that of Stephen Robbins ("Robbins"). Praegitzer shares became publicly traded not long before he delivered 2,900,000 of those shares to Credit Bancorp. The value of those shares has declined sharply from that time to the present. See Stappas Decl. ¶ 9 and Exhs. G, H, I; 6/28/00 Receiver Decl. Exhs. 32, 33. Robbins, by contrast, deposited mostly common stocks and mutual funds, which increased substantially in value between the date of deposit and the date of the asset freeze. See id. ¶ 13; 11/6/00 Receiver Decl. Exh. 2.
The Compromise Plan uses the date of investment to determine the number of shares each customer may claim and current market value to determine the worth of the claim. This approach recognizes both that customers lost control of their investments as of the date of investment, and that they had made underlying investment choices as of that date which have played a role in the value of these assets as of the present day.
Ironically, not all Stappas Intervenors would fare better under the Stappas Plan. However, there is no question that the choice of a valuation date has a dramatic impact on customers' claims.
Indeed, counsel for the Stappas Intervenors states candidly that, even as to the investors he represents, some would fare better under the date of investment approach while others would fare better under the asset freeze approach. See Letter from Sheldon Weiss to the Court of June 5, 2000.
The fundamental problem with the Stappas Intervenors' approach is that, once an investor handed over its assets to Credit Bancorp, the notion that value of any particular investor's "portfolio" was the product of decisions made by the investor is unrealistic. This notion is based on the faulty premise that Credit Bancorp offered a legitimate investment opportunity to its customers, whereas the record amply demonstrates that this was a fiction.
The Credit Bancorp scheme was quite sophisticated and, thus, employed a range of devices to perpetuate the illusion of a legitimate business, including generating account statements, creating "portfolios" on behalf of the customers, allowing customers to make "investment-type decisions," and paying out "dividends." The fact that Credit Bancorp chose at times to follow a customer's instruction to, for example, sell or purchase securities, or to return securities to a customer, does not obviate the fact that Credit Bancorp was ultimately in control and was making use of the customers' assets for its own fraudulent purposes.
Indeed, taking the right of customers to request the return of their securities as an example, the reality is that it would not have been possible for all customers to exercise these purported rights since Credit Bancorp was speedily dissipating its customers' assets. Moreover, the "return" of securities has itself been demonstrated to be a fiction on a number of occasions, in that Credit Bancorp accomplished the "return" of securities it had already liquidated by converting other customers' assets and "returning" replacement securities.
Some customers have represented specifically that they were unable to recover their stock despite repeated efforts to do so before the inception of this litigation, when Credit Bancorp was ostensibly in legitimate operation. See Letter from Fred E. Klimpl to the Court of 10/13/00, at 1; Letter from Karla G. Sanchez on behalf of Compositech to the Court of November 1, 2000.
Similarly, for many investors, the account statements generated by Credit Bancorp were fabricated at least in part. They reflect transactions that did not occur and gains that were not achieved. They do not reflect the fact that some investors' assets had been converted and spent, as in the case of the Bob Mann Customers' cash, or sold or margined, as in the case of many customers who deposited securities.
With respect to the issue of customer control, then, it is more appropriate and realistic to consider investors as becoming similarly-situated as of the date of investment rather than the date of the asset freeze. However, the date of investment approach does suffer from certain flaws. First, it is out of sync with, and does not take advantage of, the reality that the value of the assets held by Credit Bancorp has been affected markedly by movements in the market. Indeed, one positive development since the asset freeze is that the value of the receivership estate as a whole has increased. Second, there is an argument to be made for the proposition that the underlying investment choices by the customers, which were last i.Untainted by the Credit Bancorp fraud as of the date of investment, has played a not unimportant role in determining the value of those assets at the present time.
Other than the fact that the term "corporate insider" carries with it a certain opprobrium, it is not entirely clear why these investors' interests should be accorded less weight. It may be that the position of the Stappas Intervenors is that the decline in the value of these investors' shares after first being publicly offered was predictable, and therefore these investors would gain an unjustified "windfall" under the date of investment approach. On the other hand, the SECO Intervenors argue that their status as corporate insiders renders them "the claimants most at risk." SECO Obj. at 23. In one limited respect, SECO has a point, namely; that Stephenson risks losing not only the monetary value of the Vintage Petroleum stock but control over his company.
This argument was put forth in support of yet another proposal by certain customers during an earlier round of comments, namely, to use the date of investment to determine the number of "shares" comprising each claim and the date of distribution to determine the price of "shares" comprising each claim. See Greer Letter of June 20, 2000, at 2-3. This approach, they argue, is equitable in relation to customers whose securities were sold by Credit Bancorp and cannot be traced, while at the same time taking into account the market risk assumed by each customer with respect to its underlying investment choice to purchase particular securities "well before depositing such securities with CBL." See id.; see also Letter of David J. Medina to Andrew Fields of June 20, 2000, at 2 (market value as of distribution should be used because "[c]ustomers should continue to participate in the market fluctuations of their holdings, just as the entire CBL portfolio (which indeed correlates to customers' positions) is subject to market fluctuations"); Letter from Charles Savall to Loewenson of June 21, 2000, at 1 (same).
The Compromise Plan is the only one that takes account of all these factors. On the one hand, it recognizes the importance of the date of investment as the last date when customers exercised control over their assets untainted by the Credit Bancorp fraud. On the other hand, it recognizes and makes constructive use of the fact that the value of certain holdings has increased substantially. In addition, by valuing claims based on current market value, the plan provides an incentive for customers to pay in the specified Undertaking amounts. Logically, the plan ties the Undertaking to the value of the claim, by making the former a percentage of the latter. The Undertaking methodology also recognizes the reality that the assets held by the Receiver are imperfectly liquid, that is, their value on the books could not be fully realized if the assets were simply liquidated and distributed as cash.
The Stappas Intervenors oppose the Compromise Plan even though the aggregate value of their claims is roughly equivalent as between the asset freeze date and current market valuation. Their opposition is based primarily on the contention that the increased recovery under the Compromise Plan of customers whose assets have appreciated since the asset freeze — most notably, the SECO Intervenors — will come at the expenses of all other customers. They contend that the assets available for distribution are the same regardless of the date of valuation and, therefore, if the claims of any one group are greater in absolute terms on one date than on another that gain necessarily comes at the expense of other customers. Thus, those other customers are being forced to shoulder a greater portion of the overall customer losses than they otherwise would.
The Stappas Intervenors' objection appears to rely on one of two assumptions, both of which are flawed. The first is that a wholesale liquidation would realize the stated current market value of the estate, so that the assets available for distribution would be the same regardless of the claim valuation date. The second is that it would be realistic to value claims as of the asset freeze and then require customers to make Undertaking payments representing a substantially greater percentage of the value of those claims than the 25.5% currently proposed by the Receiver, so as to generate the same funds.
As mentioned earlier, the receivership is constrained by the fact that many of its assets are in the form of securities and many of those securities are illiquid or thinly traded. The Compromise Plan recognizes this reality and proposes the Undertaking a way to generate funds for the receivership without simply liquidating the securities and thereby risking a dramatic loss in their value. The Compromise Plan also recognizes that there is a limit to what customers realistically can be expected to pay into the estate in order to recover their securities. Pragmatic concerns such as these are appropriately taken into account in determining an equitable resolution.
Moreover, the Compromise Plan provides for a supplemental distribution to customers who do not fare as well under the current market value approach, namely: customers the total value of whose claims based upon current market value has appreciated less than ten percent from its value as of the TRO, and second to customers the total value of whose claims based upon current market value has depreciated since the TRO. The SECO Intervenors object to these supplemental distributions, while the Stappas Intervenors and certain other customers do not find them adequate. In this respect as well as in others, the reality is that it is impossible for all to be satisfied. The Compromise Plan, however, has struck an equitable middle ground that takes into account the varying interests of the customers, the complexity of the situation, and the difficulties of managing the receivership assets in a way that benefits everyone and minimizes risk.
SECO objects to both aspects of the supplemental distribution. With respect to the distribution to those victims whose assets have appreciated less than 10% since the TRO, SECO maintains this provision is inequitable because it would be "funded almost exclusively by SECO." With respect to the depreciation adjustment payments, SECO maintains that many of these customers could have requested that the Receiver liquidate the securities attributable to them, while others are like SECO and are investment situations that preclude the voluntary sale of securities based on changes in market value. See Letter from Donald L. Kahl to Melton of Oct. 3, 2000, at 2-3. Since the funds for the depreciation adjustment payments will come from the assets held in Europe, and the majority of those assets are in the form of Vintage Petroleum stock, SECO avers that it should not be required to act as "insurer" for these other investors against market risk. See id. However, the depreciation adjustment payments is one of the measures which helps make the Compromise Plan equitable, in that it helps to balance the fact that SECO and certain other investors fare much better under a current market value approach than they would otherwise. Moreover, SECO's notion that it is being forced to fund the supplemental distribution or to act as an "insurer" is misplaced. This Court has the power in equity to direct the management and distribution of the receivership assets in a way that is equitable to all the customers. There are clear benefits to SECO under the Compromise Plan as compared with, for instance, the SEC Plan. The fact that the Compromise Plan has elements which SECO finds unfavorable does not make it inequitable.
Praegitzer has proposed yet another approach, which he calls the "rough justice" method. See Letter from Joel Sternman on behalf of Praegitzer to the Court of November 1, 2000. This approach would value claims based on the average of their value on the date of deposit, the date of the TRO, and at current market value. See id. Under this approach, the differences among the customers as to the advantages of each date would be reduced. Praegitzer's approach undoubtedly has some appeal and theoretically could be imported into any of the proposed plans — other than the SECO Plan. However, the Compromise Plan is also a "rough justice" approach and, indeed, provides for supplemental distributions precisely for those who do not fare as well under a current market value approach. The Compromise Plan is also, as previously discussed, appropriately pragmatic in that it provides incentives for customers who benefit under the current market value approach to pay the Undertaking amounts, while not setting those amounts at an unrealistically high level.
3. Deduction of Custodial Dividends And Loan Amounts
Both the Compromise and SEC Plans take a "net investment" approach to customers' claims. That is, customers' claims are reduced by the amount of any custodial dividend payments and loans, with interest, previously received from Credit Bancorp. The Stappas Intervenors and certain other intervenors object that this approach unfairly penalizes the "older" Credit Bancorp victims, i.e., those who entered the Credit Bancorp program at an earlier point in time.
The Stappas Intervenors focus on the issue of custodial dividends. Other customers go further and urge that they should not be obligated to turn over loan monies either, on the theory that they shouldn't be held to any agreement with Credit Bancorp since it was a defrauder. See Letter from Marge Tendler to Loewenson of November 3, 2000.
The rationale for a net investment approach is twofold. First, it is in the nature of a Ponzi scheme that customer returns are generated not from legitimate business activity but, rather, through the influx of resources from new customers. "Since all the funds were obtained by fraud, to allow some investors to stand behind the fiction that [the] Ponzi scheme had legitimately withdrawn money to pay them `would be carrying the fiction to a fantastic conclusion.'" Teletronics. Ltd. v. Kemp, 649 F.2d 1237, 1241 (7th Cir. 1981) (quoting Cunningham, 265 U.S. at 13). Thus, permitting customers to retain such gains comes at the expense of the other customers. See CFTC v. Buff Aaron Hoffberg, No. 93 C 3106, 1993 WL 441984, at *3 (N.D. Ill. 1993) (adopting net investment approach in recognition of fact that "the `profits' paid out to certain investors were actually part of the res . . . . [so that] allowing those investors an additional recovery would come at the expense of the other investors").
Second, recognizing claims to profits from an illegal financial scheme is contrary to public policy because it serves to legitimate the scheme.See Topworth, 205 F.3d at 1110 (affirming district court's adoption of net investment approach because "[t]o allow claims based on profits made in the illegal trading operations would tend to legitimatize those illegal trading operations contrary to public policy") (citing District Court opinion); Franklin, 652 F. Supp. at 169 (net investment approach "is the only one that leads to a relatively equitable economic division but also accurately treats the fake "profits' as merely redistributed capital"); cf. CFTC v. Richwell Int'l. Ltd., 163 B.R. 161, 164 (N.D. Ca. 1994) (using net investment approach in bankruptcy proceeding because recognition of "profits" of illegal trading operation would legitimize scheme).
Some customers cling to the notion that they are entitled to retain these payments because they were made pursuant to the agreements executed with Credit Bancorp. See. e.g., Letter from Karla G. Sanchez on behalf of Compositech of June 28, 2000, at 2 Such contractually-based claims, however, must give way to equitable concerns in determining the appropriate distribution plan. See Vanguard, 6 F.3d at 226 ("[E]ven if entitlement under state law could be established, that wouldn't end the matter in this federal receivership.").
The Stappas Intervenors contend that this approach has a disparate impact on older investors because custodial dividends represent a much greater proportion of their claims than they do for the claims of new investors. This is true enough, since the older customers were in the Credit Bancorp "program" longer and therefore received more custodial dividend payments. The question, however, is whether those customers are entitled to keep these monies.
The Stappas Intervenors' argument is somewhat circular in that the comparisons among older and new customers are meaningful only if one accepts that customers have a legitimate claim to the custodial dividends. If these returns were not legitimate, then it is immaterial how they compare to a given customer's total claim. The evidence demonstrates that the custodial dividends were not legitimate investment returns. There was no riskless arbitrage or other profitable investment activity on the part of Credit Bancorp. The custodial dividends were a form of fake profits generated through the fraudulent Credit Bancorp scheme.
The Stappas Intervenors aver that even if the custodial dividends were not derived from legitimate profits, they were likely in many instances to have been derived from the proceeds of margin loans taken out against those same customers' securities rather than being derived from later customers' deposits. The reality of the Credit Bancorp scheme, however, is that customers' assets were not segregated within the brokerage accounts and the proceeds of the fraud, including the Bob Mann cash deposits and margin loan monies, were commingled in Credit Bancorp's bank accounts before being used for inter alia custodial dividend payments. Under these circumstances, it is unrealistic to contend that the payment of custodial dividends was not dependent upon the fraud perpetrated on all customers.
Certain other customers, e.g., John Dillon ("Dillon"), echo the view that "[i]n reality, CBL paid the stock claimants dividends from loans secured by their own stock." Letter from James Wesley Kinnear on behalf of Dillon of June 28, 2000, at 3.
Unsurprisingly, these same circumstances lead later investors such as SECO to argue the exact obverse, namely, that since other customers have already profited from the fact that Credit Bancorp illegally margined its securities, it should be entitle to recover those securities through tracing.
The Stappas Intervenors also contend that the net investment approach is unfair because the older investors have already paid income taxes on the custodial dividend monies. However, it is also the case that those investors have enjoyed the opportunity to make use of those monies as they saw fit and, indeed, have benefitted from the time value of money.
Thus, the net investment approach may affect different investors differently, but it does not have an unfair or disproportionate impact on older investors. On the contrary, these dividends are properly deemed as coming out of the res of the Credit Bancorp estate and allowing them to be retained free and clear would be at the expense of other investors. Therefore, a net investment approach is appropriate.
4. The Compromise Plan Is Both Equitable And Feasible
Based on the foregoing discussion, the Compromise Plan emerges as the plan which is not only equitable but also realistic in its approach. The substantial benefits to all customers under this plan include reduced expense associated with delay and appeal, reduced litigation risk to the customers and the receivership, reduced administrative expenses, reduced market risk, the maximization of value from securities which are either illiquid or thinly traded, and the potential reduction of tax burdens to customers. Therefore, this is the plan that will be adopted. There are, however, some additional concerns and issues with respect to this plan that need to be addressed.
E. Other Concerns Regarding The Compromise Plan 1. Timing of The Return of The Securities
The Compromise Plan provides that upon payment of the required Undertaking, "the Receiver will take all necessary steps reasonably promptly to return to the customer the [identifiable securities under the Receiver's control] . . . provided that [those securities] are no longer subject to a valid security interest at a broker-dealer." Compromise Plan ¶ I. Some customers have expressed the view that this Court should direct to Receiver to return securities to the customers within a specified time period after the payment of the Undertaking. See. e.g., Submission from Lyndon M. Tretter on behalf of Ray of October 16, 2000 (exchange of Undertakings and securities should be simultaneous); Letter from Marge Tendler to Loewenson of November 3, 2000 (securities should be returned day after payment of Undertaking). The importance of the Receiver proceeding expeditiously is without doubt, and the Court is confident that the Receiver is fully aware of this issue. However, given the complexities involved, including the issues surrounding resolution of the margin liens, it does not appear practical to prejudge the amount of time which may be required in order to accomplish the return of securities to each and every customer. The Receiver and the customers shall keep the Court aware of how the distribution is proceeding and whether there are delays which may warrant further inquiry.
2. The Supplemental Distribution
The SECO Intervenors query whether the Undertaking percentage would be subject to change at the Receiver's discretion when applied to recovery of the European assets. See Letter from Donald Kahl to Thomas Melton of Oct. 3, 2000, at 2. Based on the language of the Compromise Plan, the Undertakings percentage is not subject to change once it has been set, although the Receiver may determine at the outset that a percentage other than the estimated 25.5% may be required. See Compromise Plan ¶¶ B(16), F, L.
3. The European Assets
A number of customers have expressed concern that the Compromise Plan does not provide for customers whose assets are held in the European institutions to obtain recovery based on those assets until such time as those assets are brought under the Receiver's control. See Letter from Matthew J. Brief on behalf of the Fiaccone Trust to Oliver Metzger of October 23, 2000; Letter from Jon, Karen, and Henry Greer to Oliver Metzger of October 25, 2000; Letter from Sheldon Weiss to the Court of November 1, 2000 at 8-9. It has been proposed that the European assets should be treated as missing, like assets which have been sold, and that these customers should share accordingly in the distribution to customers with missing assets. See, e.g., Weiss Letter of November 1, 2000.
Some of these customers may also have deposited assets that are held in the United States, or that have gone missing altogether. Recovery based on those assets is obtainable as for other customers.
The European holdings question is a troubling one given the uncertainties involved as to when, or even whether, the Receiver will obtain control over those assets. The difficulty, however, is that the Receiver's carefully crafted plan does not permit for an additional $39 million in European assets to be simply added into the tally of "missing" assets. Indeed, the European securities are valued at an amount — approximately $39 million after accounting for margin loans — that is greater, than the current missing assets sum — approximately $36.5 million. See 11/6/00 Receiver Decl. Exh. 2.
There are hard realities underlying the structure of the Compromise Plan in this regard, namely, that because the European assets are frozen they cannot be employed through the Undertaking methodology to generate funds for the receivership. Thus, in order to treat these assets as "missing" and make distributions accordingly, the customers would be required to make drastically greater Undertaking payments. This appears to be unrealistic. Yet, for the reasons previously discussed, the Compromise Plan is the best and most equitable solution overall.
However, given the vagaries of why a particular customer's assets may have ended up being held by a European institution as opposed to a domestic one, the Receiver is directed to inform the Court if there is any modification or additional step which could ameliorate the situation of these investors.
The Greer customers have proposed that the identifiable European assets "should be used in calculating the Undertaking Percentage," and that in order to accomplish this the Receiver could extend a loan to customers whose assets are currently held in the European accounts in order assist them in raising the cash necessary to pay the requisite Undertaking amounts. See Letter from Jon, Karen, and Henry Greer to Oliver Metzger of October 25, 2000. How such a proposal could work, however, is unclear, especially if the intent is to treat all of the identifiable European assets as missing (since that would seem to require a substantial increase in the Undertaking percentage for all customers). Moreover, it is not apparent how the Receiver could at one and the same time make such loans and yet have cash available to make distributions not presently contemplated under the plan, i.e., based on European assets not yet under his control.
Also in relation to the European assets, the SECO Intervenors have requested that the Court specify that the Undertakings made in relation to the European assets not exceed the amount necessary to make the supplemental distributions provided for in the Compromise Plan. See Letter from Donald Kahl to Thomas Melton of Oct. 3, 2000. The data provided for the Receiver indicates that the amount projected to be generated by the European assets Undertaking payments is roughly equivalent to the amount required for the supplemental distributions. However, it would not be useful at this juncture to attempt to dictate to the Receiver in the manner sought by SECO. The Receiver has provided documentation of the financial needs of the receivership estate, see 11/6/00 Receiver Decl., and submits regular reports to the Court on his activities and expenditures. Just as it is possible that the Receiver might unexpectedly generate more money than is required for the supplemental distributions, so it is also possible that something will occur that would require that additional sum to be spent on legitimate needs of the receivership. The customers are free to object at a later point if they believe that funds are not being employed properly.
The total value of the European assets is approximately $41.3 million, of which 25.5% is $10.5 million. See 11/6/00 Loewenson Decl. Exh. 2. The sum of the supplemental distributions is approximately $8.4 million and $2.5 million, or roughly $10.6 million. See id.
4. Credit Bancorp "Insiders"
The SEC has recently raised the issue of whether Credit Bancorp "potential insiders" should be included in any distribution plan. See SEC Transmittal Mem. at 7. The SEC defines these persons as "salespeople or other individuals who are investors but who also profited from Credit Bancorp's illegal activities," and opposes their inclusion upon "a proper showing" of their involvement in the fraud. See id.
At least one Credit Bancorp employee, Glenn M. Hobin ("Hobin"), has responded to this issue and expressed his concern that he not be excluded merely on the basis of his employment relationship with Credit Bancorp.See Letter from Fred M. Plevin on behalf of Hobin to Oliver Metzger of October 24, 2000. According to Hobin, although he was an officer of one of the Credit Bancorp subsidiaries, he believed that Credit Bancorp was a bona fide business and himself became an unwitting victim of the fraud when he deposited his own assets into the scheme. See id.
Hobin is included in the list of customers slated for the partial distribution. See 11/6/00 Receiver Decl. Exh. 2.
The SEC has not proposed a specific procedure for determining whether certain individuals should be excluded from the partial distribution, which is founded in equity, based on their "unclean hands" as persons who actually participated in the fraud. Certainly, procedural due process should be respected. See Elliott, 953 F.2d at 1566-67 (discussing procedural due process in context of in adjudicating claims to receivership assets). The form which such process should take need not be prejudged. See id. (discussing various types of procedures, including "summary proceedings," which have satisfied procedural due process in equity receivership context).
If the SEC comes to believe that a particular individual is not entitled to take part in the distribution based on his involvement in the Credit Bancorp fraud, then the SEC shall so notify the Court, the parties, and the individual(s) in question. The SEC shall also propose a procedure for resolving the issue. The Court will then determine the appropriate procedure and resolve the dispute. The SEC shall act promptly in bringing such matters to the Court's attention. For example, if there are individuals whom the SEC has already identified as potential candidates for exclusion, it shall so notify the Court forthwith.
5. Praegitzer
Praegitzer has objected to the valuation of his claim under the Compromise Plan. Praegitzer had deposited 2.9 million shares of Praegitzer Industries, Inc. ("PII") shares with Credit Bancorp. Subsequent to the asset freeze, Praegitzer requested then-fiscal agent Loewenson to permit the tender of the PII shares because Praegitzer was obligated to tender those shares prior to November 30, 1999, pursuant to a merger agreement. At the time, the receivership holdings included 2, 606,500 PII shares held in several different brokerage accounts — 293,500 shares of the 2.9 million Praegitzer had deposited with Credit Bancorp were missing.
Pursuant to Praegitzer's request, Loewenson approved the tender of the 2,606,500 PII shares and notified the financial institutions at which the shares were held accordingly. Loewenson further notified these institutions that the tender proceeds were subject to this Court's asset freeze order but that it was "permissible for the proceeds to be invested in United States Treasury securities or a money market fund that invests solely in United States Treasure securities." See Letter from Loewenson to Tasin Co., Legg Mason, Dreyfus, Deutsche Bank, CISC, Schwab, and Ameritrade of November 24, 1999. Contrary to Loewenson's directive and this Court's freeze order, the firms subsequently applied the proceeds of the tender of feting to offset negative cash balances or margin balances in the accounts in which the shares had been held.
The Compromise Plan values Praegitzer's claim with respect to the tendered PII shares as the tender proceeds amount (2,606,500 shares at $5.50/share or $14,335,750.00) minus the amount of custodial dividends received by Praegitzer ($1,108,664.14). See Compromise Plan ¶ B(12). The plan values Praegitzer's claim for the untendered, missing shares as a claim for missing assets based on the value of the PII shares at the time of the tender (293, 500 shares at $5.50/share or $1,614,250.00). See id.
Praegitzer contends that he is entitled to have the tendered shares portion of his claim valued so as to include interest that would have been earned on those proceeds since the tender if not for the depository institutions' actions. See Letter from Sternman on behalf of Praegitzer to Loewenson of October 2, 2000; Letter from Sternman on behalf of Praegitzer to Loewenson of September 20, 2000.
Praegitzer contends for purposes of illustration that he is entitled to the rate applicable to United States Treasury securities, and proposes the rate of 5.64%. Although he does not explain why he chooses this rate, it is apparent from the stipulation that it is because the broker-dealers would have been entitled to invest the tender proceeds in United States Treasury securities. See Praegitzer Stip. at 3. At the rate proposed, the value of Praegitzer's claim would be increased by approximately $602,000. See Letter from Sternman to Loewenson of September 20, 2000, at 4.
In making this claim, Praegitzer relies on a stipulation he entered into with the Receiver on May 29, 2000 and so ordered by this Court on May 25, 2000 (the "Praegitzer Stipulation"). The Praegitzer Stipulation sets forth the history of the tender and provides in relevant part that:
Whereas, by letter dated April 20, 2000 , the Receiver stated his intention to file a motion with the Court seeking permission "to sell off some of the shares in CBL's accounts in order to eliminate the margin debt that is secured by the securities in those accounts". . . . The Receiver's proposal, if approved and implemented, will in all likelihood be conditioned on some provision protecting the interests of those whose shares are sold and the proceeds thereof used to eliminate the margin debt.
Whereas, but for the violation of the Freeze Order by the depository institutions, the proceeds of the PII tender, together with any interest earned thereon, would still be held by the depository institutions in the same accounts that had held the PII shares and, by no earlier than the filing of the Proposed Sale Motion, the Receiver might have sought approval by the Court of a motion authorizing application of the tender proceeds, together with any interest earned thereon, to offset negative cash balances in the accounts in which the PII shares had been held subject to the Freeze Order, conditioned on some provision parallel to what the Receiver will seek in the Proposed Sale Motion to protect the interests of those whose shares may be sold and the proceeds thereof used to eliminate the margin debt.
In light of the foregoing, it is, therefore, hereby stipulated and agreed . . . that, for the purpose of . . . any plan of distribution, Pragitzer shall be entitled to the same treatment as he would be afforded had the depository institutions that held the PII shares not applied the proceeds of the tender of the PII shares to reduce said firms' margin balances in CBL accounts.
Praegitzer Stip. at 4-5.
Praegitzer focuses on the language referencing the likelihood that, but for the depository institutions actions, the Receiver would have eventually sought to apply the tender proceeds, "together with any interest earned thereon," to offset negative cash balances or margin balances "conditioned on some provision parallel to what the Receiver will seek . . . to protect the interests of those whose shares may be sold" to offset such balances. Praegitzer also points to the language that he is entitled to the same treatment as if the depository institutions had not applied the proceeds of the tender to the margin balances.
Careful examination of the Praegitzer Stipulation confirms that the reasonable interpretation is that it does not entitle him to have an amount equal to interest the tender proceeds would, hypothetically, have generated added to his claim. First, the provision referencing the Receiver's likely application of the tender proceeds "together with any interest earned thereon" does not entitle Praegitzer to interest. Rather, this provision reflects the fact that if there had been any interest earned then the Receiver might have sought to include that amount in any application to apply the tender proceeds towards margin debt. of course, there was no interest earned since the proceeds were applied to the margin balances rather than being held by the depository institutions as they should have been.
Second, the clause stating that application of the tender proceeds by the Receiver would have been "conditioned on some provision parallel to what the Receiver will seek . . . to protect the interests of those whose shares may be sold" does not require that the "parallel" provision be in the form of interest. On the contrary, allowing Praegitzer to claim interest that was never earned would not be "parallel" to the procedures adopted under the Compromise Plan for protecting the stock investors. In fact, the Compromise Plan does provide Praegitzer with the requisite "parallel provision": it entitles him to the supplemental distribution paid to "non-appreciators." See Compromise Plan ¶ M; 11/6/00 Receiver Decl. Exh. The plan also entitles cash claimants to the supplemental distribution. See Compromise Plan ¶ M.
The Supplemental Distribution is paid to investors whose claims appreciated less than ten percent since the TRO and to cash claimants.See Compromise Plan ¶ M. Praegitzer's claim was worth $15,677,423.49 as of that date and is estimated to be worth $15,590,000 at current market value. See 11/6/00 Receiver Decl. Exh. 2. This increase in value is due to the increase in value imputed to the missing 293, 500 PII shares, as with other customers who have missing shares. See id. Compromise Plan ¶ M. Praegitzer's supplemental distribution is calculated based on his total claim. See 11/6/00 Receiver Decl. Exh. 2.
Praegitzer objects that his situation is unique, and that it is not adequate to treat his claim like those of the cash customers. See Letter from Sternman to Loewenson of September 20, 2000 at 2. However, the fact that under the methodology ultimately proposed by the Receiver the "parallel provision" afforded to protect Praegitzer's interests is also afforded to the cash claimants does not render that provision violative of the Praegitzer Stipulation.
Of course, the method adopted by the Compromise Plan for addressing the margin debt (collecting "undertakings") is not the same method contemplated in the Praegitzer Stipulation (selling off shares). Nonetheless, the reasonable interpretation of the stipulation is that it still entitles Praegitzer to parallel protections.
Finally, the provision that Praegitzer is entitled to the "same treatment" as he would have received if the depository institutions had not misapplied the tender proceeds does not entitle Praegitzer to interest that was never earned. The question is what the term "same treatment" means. Reading the stipulation as a whole and, in particular, the paragraphs immediately preceding the "same treatment" paragraph, the reasonable interpretation of the "same treatment" clause is that it is simply an affirmative restatement of the hypothetical "might have sought approval . . . conditioned on some provision parallel provision" clause in the preceding paragraph. Thus, the "same treatment" to which Praegitzer is entitled is a "provision parallel" to that afforded the stock claimants. As previously explained, the Compromise Plan affords such treatment to Praegitzer. Therefore, he is not entitled to claim interest under the stipulation, and the valuation of his claim as proposed under the Compromise Plan will be approved.
6. Pursuit of Customer Claims For Damages
Some customers have urged the Court to make clear that they are not precluded from pursuing claims for damages against the defendants in this action or other parties, such as the insurers. Suffice it to say that no conclusion to the contrary is reached herein.
7. Cash Deposits Intended To Generate Money Market Returns
At least one customer has objected that he is entitled to accrued interest on his cash deposit because his deposit was made with the intention of receiving interest from a money market fund. See Letter from Paul M. Henderson ("Henderson") to Oliver Metzger of November 2, 2000. The Compromise Plan treats claims based on such deposits like other cash claims, such as those of the Bob Mann customers, that is, it values them based on the amount deposited. See 11/6/00 Receiver Decl. Exh. 2. The objection is that cash depositors are being treated less favorably that securities depositors. See Letter from Henderson to Oliver Metzger of November 2, 2000. However, the fact that an investor intended for his cash deposit to generate interest from a money-market fund does not entitle him to such monies. The Bob Mann customers intended for their cash deposits to be invested in stocks and were furnished with monthly statements representing that such investment had occurred when the reality was that their cash was immediately converted and spent by Credit Bancorp. If it is fair to hold the claims of the Bob Mann customers to the amount of cash deposited, which it is, then it is fair to treat the claims of individuals such as Henderson similarly. 8. Stock Splits
At the proceedings held on October 18, 2000, the Bob Mann customers expressed their support for the Compromise Plan.
Some customers have sought clarification as to whether the Compromise Plan includes shares derived from stock splits among the "shares claimed" by a particular investor. See Letter from Jon, Karen and Henry Greer to the Court of November 1, 2000; Letter from Donald L. Kahl on behalf of SECO to the Court of November 1, 2000, at 5.
The Compromise Plan defines "shares claimed" as the total number of shares deposited by a customer minus any shares previously returned and "adjusted for any splits or other similar activity." Compromise Plan ¶ B(13). This definition would appear to include shares derived from stock splits. However, in the materials provided documenting the number of shares claimed per customer, it is not clear whether such shares are included. See 11/6/00 Receiver Decl. Exh. 2. The same is true for the Undertaking payment amounts. See id. If the Receiver does not intend to include shares derived from stock splits then he shall notify the Court so that the Court may make a determination as to this issue.
9. The Possibility of Future Distributions
Some customers have raised a concern that approval of a plan of distribution not preclude future distributions in the event that additional resources become available, in particular by virtue of the Coverage Action. See, e.g., Letter from Klimpl to the Court of November 9, 2000. There is nothing inherent in the Compromise Plan which precludes future distributions. Indeed, if the Receiver is successful in the Coverage Action then there may be significant additional funds. Thus, whether a future distribution is both feasible and in accordance with this court's equitable powers is a matter for another day.
Conclusion
Therefore, for the reasons set forth above, the motion by the SECO Intervenors for partial summary judgment is denied, the Compromise Plan is approved, and the motion for permissive intervention by Deutsche Bank is granted. A proposed order effectuating the Compromise Plan has been submitted by the Receiver and will be settled at a hearing at 9:30 AM on December 6, 2000. Any counter orders along with any supporting material, as well as any of the additional materials called for on the part of the Receiver by this opinion, will be served and filed by 12 noon on December 5, 2000.
Namely, information regarding a possible modification as to customers with assets held in the European accounts; and information concerning whether the Court has properly interpreted the plan's provision regarding stock splits.
It is so ordered;