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.
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
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.
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."
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.
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.
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."
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.
Read additional articles
at The Ponzi
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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