Determined not to hold a securities brokerage firm liable
for fraudulent transfers in a Ponzi scheme case, the Fourth Circuit recently
pushed the boundaries of fraudulent transfer law to affirm the lower court's
dismissal of the trustee's claims against it. Grayson Consulting, Inc. v. Wachovia Securities, LLC (In re Derivium Capital LLC), 2013 U.S.
App. LEXIS 10529 (4th Cir. May 24, 2013) [an enhanced version of this opinion is available to lexis.com
Although several aspects of the decision applied
established case law, two holdings explored new territory. The court affirmed
the dismissal of claims to recover securities transferred to Wachovia on the grounds
that they were not transfers of property of the debtor. The court also affirmed
the dismissal of claims to recover commissions on the grounds that the safe
harbor provisions of § 546(e) protected those payments.
In Derivium's scheme, its customers were induced to transfer
stocks in exchange for three-year non-recourse loans worth 90% of the stocks'
market values. When the loans matured, customers had the option of repaying the
principal plus interest and recovering the stock, surrendering the stock, or
refinancing the loan for an additional term. Customers transferred their stocks
into Wachovia brokerage accounts in Derivium's name. They were told that
Derivium would hedge their collateral using a confidential, proprietary
formula. Instead, Derivium's owners directed Wachovia to immediately transfer
the stocks into other accounts and liquidate them. Derivium used the proceeds
from the stock sales to fund customers' loans and start-up ventures of
Derivium collapsed when it could no longer satisfy its obligations
to return customers' stocks and Wachovia closed its brokerage accounts. After
Derivium filed bankruptcy, the trustee filed a complaint against Wachovia
asserting several claims, including fraudulent transfer claims to recover $161
million in securities that customers transferred into the Wachovia brokerage
accounts, and commissions that Derivium paid to Wachovia.
The court found that the transfer of the customers' securities
to an account in Derivium's name at Wachovia was not a transfer of Derivium's
property. The court stated:
Derivium had no rights to the securities until after the
transfers were effectuated. Accordingly, the Customer Transfers at issue here
simply were not transfers of debtor property, and thus the transfers in no way
diminished the bankruptcy estate.
*9. In other words, because Derivium's customers transferred their securities
directly into Derivium's account at Wachovia, rather than to Derivium first,
there was no transfer of Derivium's property to Wachovia. The court cited no
prior cases in support of this precise focus on the form and timing of the
challenged transfers. Interestingly, the court did acknowledge on several
occasions that the securities were Derivium's collateral for its loans to its
customers. The decision raises the question of whether the court put form over substance since it was clear that the customers
intended to transfer securities to Derivium, not to Wachovia.
This decision is also the first appellate decision to
hold that commission payments can be shielded from recovery by the "settlement
payment" defense of § 546(e).
The court reasoned:
Because Congress included in the definition of
"settlement payment" "any other similar payment commonly used in the securities
trade," we also look to standard practices of the securities industry to inform
the definition of "settlement payment." Several industry texts suggest that
"settlement payment" means the transfer of funds paid in connection with
completing a securities transaction.
*18. The court then quoted two such industry texts, but neither quote asserts explicitly
that commissions are included within the scope of "settlement payments." Id. at *18-19. The only text cited that
explicitly so suggests is Black's Law Dictionary, but the court does not
explain why this is an "industry text" in the securities industry. Id.
Nevertheless, the could held, "commissions shown to be
reasonable and customary parts of settling stock sales come within the
stockbroker defense as 'settlement payments.'" Id. at 20. The court then affirmed the bankruptcy court's factual
finding that Wachovia's discounted commission rates were reasonable and
customary. Id. at *21.
The court did emphasize, however, that its holding does
not apply to commissions that are "not part of the settlement of securities
transactions, such as commissions paid for the solicitation of investors[.]" Id. at *19.
The Fourth Circuit's narrow view that the debtor's
property did not include securities that collateralized loans from the debtor
to its customers, coupled with the court's expansive view of the "settlement
payment" defense, gives brokerage firms substantial new armor against trustee's
fraudulent transfer claims in Ponzi scheme cases. Will other courts follow?
Read additional articles at The Ponzi Scheme
Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal
Resource for Unraveling Ponzi Schemes (LexisNexis 2012), along with
Hon. Steven Rhodes. The Ponzi Book, recently reviewed by the ABI Journal and Commercial
Crime International, is available for purchase at www.lexisnexis.com/ponzibook,
and more information about the book can be found at www.theponzibook.com.
Watch Kathy's interview on the The Not So Legal Show.
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