Opinion
99 Civ. 11395 (RWS)
July 31, 2002
MORRISON FOERSTER Attorneys for Court-appointed Receiver, New York, N.Y. 10104, By: ANDREW J. FIELDS, ESQ. OLIVER METZGER, ESQ. ELEONORE F. DAILLY, ESQ. of Counsel.
GOLENBOCK, EISEMAN, ASSOR, BELL PESKOE Attorneys for Court-appointed Receiver, New York, N.Y. 10022, By: DAVID J. EISEMAN, ESQ., ADAM C. SILVERSTEIN, ESQ. of Counsel.
SECURITIES AND EXCHANGE COMMISSION Salt Lake City, UT 84103, By: THOMAS M. MELTON, ESQ. Of Counsel.
WOLLMUTH MAHER DEUTSCH Attorneys for Stephenson Equity Company New York, N.Y. 10110, By: WILLIAM A. MAHER, ESQ., FREDERICK R. KESSLER, ESQ. Of Counsel.
LAYTON BROOKS HECHT Attorneys for Charles Schwab Co., Inc. New York, N.Y. 10022, By: DANIEL J. BROOKS, ESQ. Of Counsel.
HALL, ESTILL, HARDWICK, GABLE, GOLDEN NELSON Attorneys for SECO Tulsa, OK 74103-3708, By: DONALD L. KAHL, ESQ., T. LANE WILSON, ESQ. Of Counsel.
OPINION
Carl H. Loewenson Jr., Esq., as Court-appointed Receiver (the "Receiver") for Credit Bancorp Ltd. and affiliated entities (individually and collectively "CBL" has moved for approval of settlement agreements between the Receiver and (1) NFSC/Chase, (2) Ameritrade, Inc., ("Ameritrade") and (3) Charles Schwab Co. ("Schwab"). Because the Receiver has not abused the discretion granted to him in this Court's January 2001 Opinion in concluding the settlements, the motions are granted.
Prior Proceedings
Certain of the prior proceedings are described in previous opinions of this Court, familiarity with which is presumed. See SEC v. Credit Bancorp, Ltd., 147 F. Supp.2d 238 (S.D.N.Y. 2001); SEC v. Credit Bancorp Ltd., 93 F. Supp.2d 475 (S.D.N.Y. 2000)
In this case an equity receivership was established on January 21, 2000. SEC v. Credit Bancorp. Ltd., No. 99 Civ. 11395 (RWS) (S.D.N.Y. Jan. 21, 2000) (the "January 2000 Order"). The Receiver was directed, inter alia, to marshal Credit Bancorp's assets in order to ultimately effect a return of property to Credit Bancorp's customers.
As part of its illegal activities, CBL wrongfully deposited customer-owned securities into securities accounts in its own name held by a variety of securities broker/dealers, including Schwab, Ameritrade, and NFSC/Chase. The broker/dealers, including Schwab, Ameritrade, and NFSC/Chase, then made margin loans to CBL.
The Proposed Settlements
As of March 31, 2002, the margin loan outstanding in the Schwab account was $1,685,890.84 and the total value of the assets in the account was $9,978,219.13. The settlement provides for the Receiver to pay Schwab the margin debt claimed by Schwab, less $150,000. Upon payment of the settlement amount, Schwab will transfer all of the assets in the account to the possession, custody and control of the Receiver. Assuming the settlement is consummated before any substantial change in the value of the account, the Receiver will gain control of more than $8.3 million worth of assets. Until such time as the settlement is effectuated, interest continues to accrue at the rate of approximately $7,500 per month.
As of March 26, 2002, the nominal margin debt owed by CBL to Ameritrade was approximately $3,708,178. Pursuant to the settlement, Ameritrade agrees to forgive $210,000 of this debt, constituting approximately 5.7% of the total amount that would nominally be due to Ameritrade in the absence of settlement.
As of April 15, 2002, the margin debt owed by CBL to NFSC/Chase was $1,112,439.24. Pursuant to the settlement, NFSC/Chase agrees to forgive $44,000 of this debt, constituting 3.9% of the total amount that would be nominally due to NFSC/Chase in the absence of a settlement.
Plaintiff-Intervenor, Stephenson Equity Company ("SECO"), CBL's largest customer, objects to the proposed settlements for substantially the same reasons that it opposed approval of the settlement between the Receiver and the Pershing Division of Donaldson, Lufkin, Jenrette Securities Corp. ("Pershing"). By memorandum opinion dated December 20, 2001 (the "December 20, 2001 Order"), the Pershing settlement was approved over SECO's objections. SEC v. Credit Bancorp, Ltd., 2001 WL 1658200 (S.D.N.Y. Dec. 27, 2001). In that order, it was held that the settlement was well within the Receiver's discretion. The order also rejected SECO's argument that because the Receiver has an obligation to "all claimants or persons interested in the estate" the settlement was not within his discretion, noting that the Receiver had made a determination that the interests of all parties are best served by this settlement.
The Validity of Schwab's Margin Lien
SECO asserts that Schwab's margin lien is invalid because Schwab had or should have had knowledge of adverse claims after Schwab officers questioned the legitimacy of the CBL scheme after receiving promotional materials from CBL.
On February 9, 1998, Schwab's Co-Chief Executive Officer, David S. Pottruck ("Pottruck"), received a solicitation in the mail from CBL inviting him to deposit his Schwab stock in an "insured credit facility" in exchange for which he would receive a "custodial dividend" of 6%. Pottruck reviewed the solicitation for a few minutes before sending it on to Schwab's in-house attorneys. During his review of the solicitation, Pottruck formed the impression that CBL "looked like a bona fide organization," but he had a "hard time understanding how someone could pay that kind of money and where they would make their money." Pottruck was curious about whether others thought this plan could be legitimate, so he sent the solicitation to the in-house counsel. Pottruck testified that CBL's offer seemed "too good to be true."
Scott Cook ("Cook"), the Schwab in-house lawyer who looked into the CBL solicitation, testified that he never discussed CBL with Pottruck. Cook researched CBL by obtaining a Dun and Bradstreet report and by searching LEXIS. Neither source raised any particular concerns. Cook stated, however, that certain aspects of the CBL solicitation (i.e. that the assets were "completely safe with guaranteed interest" and "completely insured") echoed fraud schemes of which Cook, who had previously worked at the SEC, had been aware. For that reason, Cook forwarded copies of the solicitation to the San Francisco office of the SEC. Cook informed the SEC: "Not certain this deal is a fraud, but we thought it appropriate to inform you as you may want to investigate."
Pottruck and Cook asserted that they did not believe that CBL would attempt to open an account with Schwab. CBL's solicitation indicated that the "insured credit facility" into which the securities would be deposited would be at a large bank or brokerage firm in New York, which both Pottruck and Cook understood not to be a reference to a brokerage firm such as Schwab, which is a San Francisco-based discount broker.
At the time Pottruck received the solicitation and at the time Cook received, investigated and forwarded the solicitation, Schwab did not have the technological means to block a potential customer from opening an account at Schwab. Schwab has since obtained that ability through a device called a "hot file," implemented in April 1999. Prior to that time, Schwab had to rely on a credit check by an outside vendor.
On May 21, 1998, CBL opened an account at Schwab. Because the account was opened at Schwab's London branch, British law required that, in addition to completing the normal application forms, CBL also provide a letter of recommendation from a firm of solicitors. CBL's application was correctly filled out and raised no red flags. Because CBL was approved to open an account at Schwab, no special requirements were needed in order to obtain a margin account as opposed to a cash account.
All of the securities transferred into CBL's account at Schwab, including SECO's Vintage Petroleum stock, were received by Schwab by automated and standardized electronic means from the Depository Trust Company ("DTC") or via the Automated Customer Account Transfer service ("ACAT")
The Receiver has investigated the validity of the margin lien held by Schwab. The investigation involved the production of thousands of pages of documents by Schwab and the depositions in San Francisco and London of six Schwab employees, including Pottruck and Cook.
The Validity of Ameritrade's Margin Lien
SECO challenges the validity of Ameritrade's lien because of the purported lack of any procedures to ensure due diligence.
As an Internet-based on-line brokerage firm, Ameritrade maintains brokerage accounts for customers who do their own accounts and trading. Unlike traditional brokerage firms, Ameritrade does not assign a specific registered representative or team of registered representatives to handle specific accounts, including corporate accounts such as CBL's. Transactions are customer-driven.
In August 1998, CBL sought to open an account at Ameritrade. CBL initially failed to supply Ameritrade with the appropriate documentation, e.g., corporate resolutions. Thus Ameritrade sought additional information demonstrating that CBL was authorized to open and maintain such an account.
In February 1999, CBL submitted the necessary documentation. Ameritrade then reviewed the documentation, consisting of:
• CBL's account application, which identified, inter alia, CBL's status as a foreign corporation, its annual income, net worth, liquid net worth, investment experience and objectives;
• the corporate resolution authorizing CBL to open a brokerage account;
• a certificate of an officer authorized to act on behalf of CBL;
• CBL's Internal Revenue Service Form W-8 Certificate of Foreign Status;
• a certificate verifying that CBL was duly incorporated and that an officer was duly authorized to act on its behalf;
• a certificate documenting CBL's status as a foreign corporation; and
• CBL's articles of incorporation.
Ameritrade followed its normal account procedures and approved CBL's cash margin account after reviewing the above documents.
Both the Receiver and SECO had two years to conduct discovery concerning Ameritrade's lien against the account. Ameritrade has produced hundreds of documents in response to document requests and produced a Rule 30(b)(6) witness who testified at length regarding Ameritrade's account opening procedures.
The Second Circuit Decision
The instant motions to approve the three settlements were filed on March 26, 2002 (Schwab); April 25, 2002 (Ameritrade); and May 13, 2002 (NFSC/Chase)
Prior to oral argument, on May 9, 2002, the Second Circuit in SEC v. Credit Bancorp Ltd., 290 F.3d 80 (2d Cir. 2002) decided a prior appeal by SECO, focusing on the single issue of "whether the shares of stock transferred to a company that defrauded the transferor and numerous other victims can be included in the receivership estate of the defrauding company for the purposes of a pro rata distribution of the defrauded victims." Id. at 82. The Court answered that question affirmatively, and held that (1) the shares of Vintage Petroleum, Inc. ("Vintage") transferred by SECO to CBL are within the receivership estate and (2) this Court had the equitable discretion to approve the Compromise Plan, which provides for the distribution of the receivership estate's assets to CBL's defrauded customers on a pro rata basis. Id. at 91.
The decision foreclosed one of SECO's arguments against approving the settlement. SECO argued that the Court should wait until the appeal was decided. As discussed supra, the decision does not augment SECO's argument.
The Court did not analyze the issue before it as one of "at-law claims versus equitable considerations." Rather, it analyzed the nature of SECO's interest, concluding that it was a beneficial trust arising from a constructive trust, and then held that such an interest does not defeat the Court's equitable authority to treat all victims alike. The Second Circuit held that CBL's victim's parted with legal title to the assets that were transferred to CBL and which CBL pledged as collateral for margin loans. The Second Circuit expressly rejected SECO's attempt to align itself with "holder[s] of a perfected security interest." Id. at 90 (citing Foothill Capital Corp. v. Clare's Food Market, Inc., 113 F.3d 1091, 1098-99 (9th Cir. 1998)).
By letter dated May 21, 2002, the Securities and Exchange Commission ("SEC") expressed its support for the settlements as "in the best interests of all of the investors in this matter," noting that the Receiver had "demonstrated that there are valid and compelling reasons to pay these margin loans." Further, the SEC noted that the only investor who has opposed the payment of these three margin loans is SECO, and that "[a]ll investors are being penalized because of SECO's opposition."
Because of the similarity of SECO's objections to the motions, the parties requested that all three motions should be heard and decided together. This request was granted, and the motions were heard and marked fully submitted on May 22, 2002.
Because the proposed settlements with the three brokers are well within the discretion granted to the Receiver by the January 2000 Order, the motions are granted.
Discussion
I. The Proposed Settlements Fall Within the Broad Discretion Granted to the Receiver
In the January 2000 Order, this Court authorized the Receiver to "investigate, prosecute, . . . compromise, and adjust actions in any state, federal or foreign court or proceeding of any kind as may in his sole discretion be advisable or proper to recover or conserve funds, assets and property of Credit Bancorp." Order at ¶ IV; see also id. at ¶ I. (c) (granting Receiver authority to take actions that prevent dissipation of assets). This comports with the ordinary practice for receivers:
Since the court has authority to authorize a receiver to collect assets of a corporation, it has the further authority to authorize the receiver to sue to collect the assets of the corporation. It naturally follows, as a necessary corollary of the foregoing, that the receiver has the power, when so authorized by the court, to compromise claims either for or against the receivership and whether in suit or not in suit.
3 Ralph Ewing Clark, A Treatise on the Law and Practice of Receivers, § 770 (3d ed. 1959)
In opposing the Receiver's motion, SECO makes two of the same arguments that it made against the Pershing settlement. First, it argues that the three broker-dealers should not be paid because other "at law" claims have been rejected by the Receiver. Second, SECO argues that payment of any margin lien claims are not in the best interests of CBL's victims. Both arguments were rejected in the previous Order, and SECO has not made any new arguments to justify a reversal of the previous holding.
As with the Pershing settlement, the Receiver in his affidavits in support of the settlements avers that he has researched the law, conducted thorough discovery and arrived at settlements that the Receiver considers to be in the best interest of the estate.
The Schwab settlement provides for the Receiver to pay Schwab the margin debt claimed by Schwab, less $150,000. Upon payment of the settlement amount, Schwab will transfer all of the assets in the account to the Receiver, and, barring any substantial change in the value of the account, he will gain control of approximately $8.3 million worth of assets. Here, as with the Pershing settlement, delay in settlement can amount to a dissipation of receivership assets because interest is accumulating on the margin account at the rate of approximately $7,500 per month. Here, as there, the settlement will reduce the outstanding margin balance. In addition, the discount to Schwab's margin lien reflected in the proposed settlement before the Court is substantially greater than that in the Pershing settlement in both percentage and amount.
As of March 31, 2002, the margin loan outstanding was $1,685,890.84, and the total value of the assets in the Account was $9,978,219.13.
The Receiver similarly has conducted thorough factual discovery and legal research in relation to the Receivership estate's rights as against Ameritrade and NFSC/Chase and has concluded that the two settlements are in the best interests of the Receivership estate. Ameritrade has agreed to forgive $210,000 of the margin debt. NFSC/Chase has agreed to forgive $44,000 of the margin debt. In addition, as with the Schwab and Pershing settlements, delay in settlement can amount to a dissipation of receivership assets because interest is accumulating on the margin accounts. Here, as there, the settlement will reduce the outstanding margin balances.
As of March 26, 2002, the nominal margin debt owed by CBL to Ameritrade was approximately $3,708,187, and the amount forgiven constitutes approximately 5.7% of the total amount due in the absence of settlement.
As of April 15, 2002, the nominal margin debt owed by CBL to NFSC/Chase was $1,112,439.24, and the amount forgiven constitutes approximately 3.9% of the total amount due in the absence of settlement.
II. The Existence of Questions About the Validity of Schwab's and Ameritrade's Margin Liens Do Not Warrant Delaying Approval of the Settlement
In addition to the objections raised against the Pershing settlement, SECO also claims that questions exist concerning the validity of Schwab's and Ameritrade's margin lien claims and that the Court should determine whether the liens are valid before approving the settlement.
A. Schwab
SECO argues that Schwab had actual or constructive notice of an "adverse" claim of customers and therefore does not have a perfected security interest. This is because Pottruck received information from CBL and forwarded it to the legal department because he thought the offer seemed "too good to be true." Schwab's legal counsel to whom the materials were forwarded, Cook, then forwarded copies of the solicitation to the SEC because he thought they might want to investigate. However, at that time, CBL did not have an account with Schwab, and Schwab did not have any technology in place to block a potential customer. In addition, Schwab took the normal security precautions with CBL. In fact, because CBL opened the account in London, Schwab followed the more strenuous requirements of British law.
The Receiver has explored the factual and legal issues arising from Schwab's conduct, and has taken into account the questions regarding the validity of Schwab's margin lien in determining the settle on the terms contained in the proposed settlement. Based on the analysis of all relevant information, including the fact that there was no CBL account at Schwab either at the time Pottruck received the CBL materials, or at the time the CBL material was forwarded to the SEC, the Receiver determined that the benefit to the Receivership estate from the settlement outweighed the likely benefit from a legal challenge to the validity of the liens. That determination is within the Receiver's discretion.
The very point of a settlement is to avoid litigating, and deciding, an issue with respect to which both parties wish to avoid the risk of litigation. Here, the issue is the validity of Schwab's lien. If the Court is going to be required to decide the validity of Schwab's margin lien, as SECO requests, the settlement is irrelevant: either Schwab will be paid the full amount or Schwab has no lien and is merely an unsecured creditor. The compromise agreed to by the Receiver and Schwab eliminates the need to adjudicate the validity of Schwab's lien.
B. Ameritrade
SECO also argues that questions exist concerning the validity of Ameritrade's lien because it claims that Ameritrade had no procedures in place to ensure that it exercised due diligence in delivering information concerning an adverse claim to the appropriate individuals in Ameritrade.
Ameritrade claims that it satisfied all relevant obligations including making "reasonable efforts to obtain certain basic financial information from customers so that members can protect themselves and the integrity of the securities markets from customers who do not have the financial means to pay for the transactions." NASD Notice of Members No. 01-23, 2001 NASD LEXIS 28 (April 2001), at *6 n. 7. Further, Ameritrade states that SECO has failed to identify any "suspicious circumstance" sufficient to put Ameritrade on notice of adverse claims to the shares deposited in CBL's account.
As discussed above, the Receiver has explored the factual and legal issues arising from Ameritrade's conduct, and has taken into account the questions regarding the validity of its margin lien in determining and agreeing to the terms contained in the proposed settlement. Based on the analysis of all relevant information, the Receiver determined that the benefit to the Receivership estate from the settlement outweighed the likely benefit from a legal challenge to the validity of the liens. That determination is within the Receiver's discretion.
Conclusion
For the foregoing reasons, the Receiver's motions to approve the Schwab, Ameritrade and NFSC/Chase settlements are approved.
It is so ordered.