Arbitration Award Against Wachovia Securities in Derivium Capital Ponzi Case

Arbitration Award Against Wachovia Securities in Derivium Capital Ponzi Case

The latest buzz in the Ponzi world is over the $852,000 arbitration award that former Congressman Alan Grayson won against Wachovia Securities on April 3, 2012. Grayson lost money in the Derivium Capital Ponzi scheme and sought damages of $28 million to $77 million on a variety of claims against Wachovia.  The arbitration panel found only that Wachovia aided and abetted breach of fiduciary duties and awarded Grayson far less than he sought.

     Unfortunately, the arbitration award does not include any findings explaining why Wachovia was found liable. Nevertheless, the story can be partially pieced together. First, it is necessary first to understand the Derivium scheme itself. In General Holding, Inc. v. Cathcart, 2009 U.S. Dist. LEXIS 130777 (D.S.C. July 29, 2009) [an enhanced version of this opinion is available to lexis.com subscribers], in which Grayson was one of the plaintiffs, the court made these specific findings describing the scheme:

     The scheme was effected through a financial operation known as the 90% Stock Loan Program (the "Program"). The Principals operated the Program primarily though Derivium Capital, LLC ("Derivium"), a South Carolina entity which they owned and controlled. Derivium marketed the Program through major financial publications and direct mailings to prospective borrowers (the "Borrowers") who were solicited to pledge their publicly-traded stock to Derivium as collateral for a loan in the amount of 90% of the stock's value. Each of the Plaintiffs, other than the Trustee, was a Borrower of Derivium.

     As the name implies, the Program permitted the Borrowers to borrow  up to 90% of the current value of the stock offered as collateral. Since the loan was non-recourse such that if the value of the stock decreased during the loan term, typically three years, the Borrower could surrender the stock to Derivium in satisfaction of the loan with no further obligation. Upon maturity, borrowers had the option of tendering principal and interest and demanding the return of their collateral (or the difference in cash between the stock price and the payoff amount), which the Borrower would typically elect if the stock's value had risen during the loan term.

     The use the Principals made of the collateral during the loan term was concealed from the Borrowers and even from some of Derivium's own sales force. At the Principals' direction, Derivium's employees told those who asked that Derivium would "hedge" their collateral in accordance with a highly confidential, complex, proprietary formula developed by Cathcart. In addition, Derivium's employees and its marketing materials touted Cathcart and Debevc's experience in developing derivative instruments. Through these representations, along with the company's name itself, the Principals intended to create the impression that they would employ derivative instruments to protect the value of the collateral. In fact, the Principals sold the stock immediately upon receipt, paid themselves substantial fees in the form of commissions and used the remaining proceeds to fund their own start-up companies in the construction industry, in which the Principals had no prior experience. All but one of these start-up ventures failed. Because Derivium had sold all of the stock, maintained no capital reserves, and entered into no derivative transactions, it was unable to return Clients' stock at maturity. Significantly, the Principals continued to solicit new clients and enter into new stock loans for years after the Principals knew the scheme would collapse.

   In that case, Grayson was awarded a judgment of $34,105,670 on his claim of piercing the corporate veil against Derivium's principals, Cathcart and Debevc.

   Grayson had also filed a complaint against Wachovia, in which he specifically alleged that Derivium was a Ponzi scheme. "[T]he Derivium Owners sometimes were using funds derived from new transactions carried out in Defendants' brokerage accounts to pay off funds owed on old transactions, the very definition of a Ponzi scheme." See Grayson Consulting, Inc. v. Wachovia Securities, LLC (In re Derivium Capital, LLC), 2008 Bankr. LEXIS 4109 (Bankr. D.S.C. June 10, 2008) [enhanced version]. Grayson asserted claims that Wachovia aided and abetted the Derivium Owners in fraud, breach of fiduciary duty, fraudulent conveyance, and conversion.  He also claimed that Wachovia was negligent, breached a fiduciary duty owed to Debtor, converted property of Debtor, and conspired with the Derivium Owners to injure Debtor. Grayson specifically alleged how Wachovia participated in the scheme:

To carry out the stock-loan program, Debtor used brokerage accounts with Wachovia and other entities. According to the amended complaint, Wachovia, at the direction of the Derivium Owners, liquidated the pledged stock to assist the Derivium Owners in the alleged fraud against the borrowers. Grayson asserts that Wachovia knew that the Derivium Owners were depicting the transactions with Debtor as stock-loans, in which the borrowers retained an ownership interest in the pledged stock, yet Wachovia nevertheless assisted in the scheme by liquidating the borrowers' stock.

     Id. However, the court dismissed all of Grayson's tort claims against Wachovia, which were brought by Grayson as the successor to the Debtor's rights against Wachovia, on in pari delicto grounds.

     Despite that dismissal, Grayson pursued nearly identical claims in a FINRA arbitration proceeding against Wachovia.  According to the arbitration award:

     Claimants asserted the following causes of action: (1) fraud: (2) aiding and abetting fraud; (3) Uniform Securities Act fraud; (4) negligent misrepresentation; (5) aiding and abetting breach of fiduciary duty; (6) conversion; (7) civil conspiracy; (8) unfair trade practices; (9) fraudulent conveyance; (10) aiding and abetting fraudulent conveyance; and, (11) quantum meruit. The causes of action relate to an alleged "stock loan" Ponzi scheme involving Claimant Grayson's entry into "stock loan" agreements with Derivium Capital LLC and Derivium Capital (USA), Inc.

    In pertinent part, the arbitration panel concluded, "Respondent is liable on the claim of aiding and abetting breach of fiduciary duty and shall pay to Claimants compensatory damages in the amount of $852,000.00, inclusive of pre-judgment interest. . . . Any and all claims for relief not specifically addressed herein, including Claimants' request for punitive damages, are denied." As noted, this award was made with no findings whatsoever. The arbitration award is here.

     On April 23, 2012, Grayson's attorneys issued a statement, "This outcome should be a warning to brokerage firms everywhere to be mindful of what is happening inside their houses. Firms cannot give sanctuary to Ponzi schemers and then turn a blind eye to bad acts taking place in their firm. If they are in a position to know that something is wrong and allow it to happen, they could be held liable to the customers victimized."

   The message to Wachovia and other brokerages would have been much stronger if the arbitrators had actually disclosed why they held Wachovia liable.

   These various types of claims are extensively covered in The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes by Kathy Bazoian Phelps and Hon. Steven Rhodes. The Ponzi Book is available for purchase at www.lexisnexis.com/ponzibook, and more information about the book can be found at www.theponzibook.com.

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Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes available for purchase at www.lexisnexis.com/ponzibook.

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