Baker & Getty Financial Services, Inc., In re

• Decision Date: 07 March 1997
• Docket Number: 96-3077,Nos. 96-3030,s. 96-3030
• Parties: 37 Collier Bankr.Cas.2d 702, 30 Bankr.Ct.Dec. 448, Bankr. L. Rep. P 77,285 In re: BAKER & GETTY FINANCIAL SERVICES, INC., Debtor. WESBANCO BANK BARNESVILLE, Plaintiff-Appellant/Cross-Appellee, v. Carl D. RAFOTH, Trustee, Defendant, Customer Creditors, Defendant-Appellee/Cross-Appellant, Mark Hocevar, Theresa M. Frissora, Defendants.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1255

106 F.3d 1255

37 Collier Bankr.Cas.2d 702, 30 Bankr.Ct.Dec. 448,

Bankr. L. Rep. P 77,285

In re: BAKER & GETTY FINANCIAL SERVICES, INC., Debtor.

WESBANCO BANK BARNESVILLE, Plaintiff-Appellant/Cross-Appellee, v. Carl D. RAFOTH, Trustee, Defendant, Customer Creditors, Defendant-Appellee/Cross-Appellant, Mark Hocevar, Theresa M. Frissora, Defendants.

Nos. 96-3030, 96-3077.

United States Court of Appeals, Sixth Circuit.

Argued Dec. 3, 1996.

Decided Feb. 12, 1997.

Rehearing Denied March 7, 1997.

Robert M. Morrow (argued and briefed), Columbus, OH, for Plaintiff-Appellant/ Cross-Appellee.

Carl D. Rafoth, Friedman & Rummel Company, Youngstown, OH, Trustee.

Russell A. Kelm (argued and briefed), Law Offices of Russell A. Kelm, Columbus, OH, for Defendant-Appellee/Cross-Appellant.

Before: ENGEL, BROWN, and COLE, Circuit Judges.

BAILEY BROWN, Circuit Judge.

WesBanco Bank of Barnesville, Ohio ("WesBanco") appeals a judgment by the district court, in which the court affirmed an earlier decision of the bankruptcy court, instructing the trustee to distribute the assets of Baker & Getty Financial Services, Inc., Baker & Getty Diversified, Inc., Baker & Getty Securities, Inc., Philip Cordek and Suzan Cordek, collectively known as the "debtors," pursuant to the stockbroker liquidation provisions of the National Bankruptcy Review Act of 1987, 11 U.S.C. §§ 741-752 (1978). WesBanco contends that the district court, by so ruling, erred in determining that the debtors were "stockbrokers" under 11 U.S.C. § 101(53A). "Customer Creditors," investors who entrusted money with the debtors for the purpose of purchasing stock, respond that the district court correctly classified the debtors as stockbrokers. In addition, Customer Creditors cross-appeal a marginal entry order by the district court, in which the district court refused to strike references to the deposition testimony of Daniel Schwenker and Philip Cordek from the record on appeal and from WesBanco's brief. For the following reasons, we AFFIRM the district court's order characterizing the debtors as "stockbrokers" and applying the stockbroker liquidation provisions and, therefore, we need not decide the issue raised by Customer Creditors in the cross-appeal.

I. FACTS AND BACKGROUND

In August 1985, Philip Cordek and Steven Medved formed Baker & Getty Financial Services, Inc. ("BGFS"), a stock brokerage and financial services firm. Medved and Cordek assumed the primary duties of organizing the business after its incorporation. By December 1985, Medved formed Baker & Getty Diversified, Inc. ("BGD") to obtain funds from various institutions and in turn loan the funds to BGFS. BGD also developed real estate investment opportunities for the customers of the brokerage firm. In May 1986, Baker & Getty Securities, Inc. ("BGS") was formed to replace BGFS and BGD because of problems encountered regarding the licensing procedures for BGFS as a securities firm. For purposes of this opinion, we will refer, as do the parties and the courts below, to the three Baker & Getty corporations collectively as "B & G."

Throughout 1985 and 1986, B & G solicited customers to purchase securities. B & G advertised itself as a licensed broker-dealer and as a member of the Securities Investor Protection Corporation, and, in addition, B & G encouraged its stockbrokers to tell prospective customers that B & G was a full-service brokerage firm, capable of conducting transactions in-house. In truth, however, B & G was neither a licensed broker-dealer nor a member of the Securities Investor Protection Corporation. Instead, B & G employed Mutual Services, Inc. ("Mutual Services"), a licensed broker-dealer, to conduct trades through a clearing house, Mesirow and Company Incorporated ("Mesirow"). Typically, B & G stockbrokers, who were also registered representatives of Mutual Services, placed orders with Mutual Services, and Mutual Services cleared the trades through Mesirow. After executing a trade, Mutual Services provided confirmation slips to both the investors and B & G stockbrokers, and commission checks to B & G stockbrokers. Thus, although investors who purchased stock from B & G licensed stockbrokers, Daniel Schwenker, David Perham, and Phil Hammond, received valid securities, they received them without knowledge of B & G's actual status.

At the same time Schwenker, Perham, and Hammond were conducting legitimate stock transactions, Philip Cordek was conducting illegitimate transactions. To attract business, Cordek told investors that his uncle, who resided in New York, had access to large blocks of common stock available for sale at a discount. Cordek told investors that he would purchase stock at a discounted price and then quickly sell it, thereby allowing the investors to make a substantial return on their investment. Relying on Cordek's representations, Customer Creditors paid various sums to B & G in order to take advantage of the alleged investment opportunities. Cordek in turn gained access to the funds as the sole signatory on the B & G bank accounts. ¹

Instead of purchasing the stocks as promised, however, Cordek pocketed the money and then paid returns to original investors by taking from principal sums contributed by new B & G investors. The result was a classic "Ponzi" scheme, an investment scheme in which investors are promised excessive returns on investments and where, typically, initial investors are paid the promised returns to attract additional investors. ² In January and February 1986, Cordek purchased stock for himself through Perham and Mutual Services, Inc. with the money received from the "Ponzi" scheme. By November 1986, Customer Creditors had lost approximately $3 million.

Meanwhile, in August 1986, Cordek and Byron Rice, a long-time customer of WesBanco, approached the President of WesBanco, Charles Bradfield, to obtain a loan. Cordek and Rice borrowed $1.1 million to invest in the bond market. ³ WesBanco requested $200,000 in collateral to be presented at the closing; however, it only perfected its interest in collateral of the value of $55,000. ⁴ On the due date for the $1.1 million promissory note, Cordek told WesBanco that he could not make the payment because he had not sold the bonds purchased with the loan money. However, Cordek testified that, in truth, he sold the bonds for a loss and deposited the proceeds of the sale into his personal account. Later, WesBanco recovered $245,800 from B & G's accounts with the bank and $237,378 from Rice on the promissory note. ⁵

On January 22, 1987, three defrauded individuals filed involuntary bankruptcy petitions against BGS, BGD, and BGFS. The petitions were not contested, and the bankruptcy court entered an order of relief against the three corporations on February 17, 1987. On April 28, 1987, Cordek and his wife were joined as affiliates. Then, on May 26, 1987, the bankruptcy court entered an order substantively consolidating the estates of B & G with those of Philip and Suzan Cordek. Matter of Baker & Getty Fin. Servs., Inc., 78 B.R. 139 (Bankr.N.D.Ohio 1987). ⁶ The bankruptcy court substantively consolidated the estates of the debtors because of unrestricted and extensive commingling of Philip Cordek's personal assets with B & G's corporate assets. WesBanco, which had been a creditor of Philip Cordek, individually, but not of B & G, then became a creditor of B & G. Thus, WesBanco would not have been a creditor of B & G at all had it not been for Customer Creditors' efforts to substantively consolidate the estates of the Cordeks with the B & G estate.

After seven years of contested proceedings, the trustee began to focus on the distribution of the recovered assets. On July 1, 1994, the trustee filed a motion for instructions from the court as to the applicability of the stockbroker liquidation sections of the bankruptcy code, 11 U.S.C. §§ 741-752. In particular, the trustee wanted to know whether he should distribute the assets of the estate under the general subchapter, 11 U.S.C. § 726, or the subchapter for liquidation of a stockbroker, 11 U.S.C. §§ 741-752. Under an 11 U.S.C. § 726 distribution, WesBanco, as well as the other general creditors, expected to receive approximately 60% to 70% of its total claim upon final distribution. Under 11 U.S.C. §§ 741-752, however, WesBanco would receive no return on its claim, while Customer Creditors received a full return. Brief for Appellant at 6.

After holding a full evidentiary hearing, the bankruptcy court concluded that the assets of the debtors be distributed under the stockbroker liquidation provisions, 11 U.S.C. §§ 741-752:

There is no dispute that the Debtor defrauded investors. The evidence in the record, however, shows that Debtor did effect transactions in securities. At a hearing on this matter, counsel for the Customer Creditors called David Perham to testify that he engaged in the business of effecting stock transactions. Perham is a licensed stockbroker who worked for Debtor during the relevant period. Perham testified that he accepted money from customers and conducted transactions in securities. Perham further testified that he personally knew of other brokers performing similar functions. Furthermore, the Court is aware from other hearings in the bankruptcy case of instances where Debtor informed investors that it had bought and later sold securities for the investors' accounts. From this evidence, the Court concludes that Debtor has effected transactions in securities.

Joint Appendix at 138-39. On appeal, the district court reviewed the applicability of the stockbroker liquidation provisions and entertained Customer Creditors' motion to strike references to the deposition testimony of Schwenker and Cordek from WesBanco's brief and from the record on appeal. On July 31, 1995, the district court issued a memorandum opinion affirming the bankruptcy court's order and entered a marginal entry order denying the motion to strike. This appeal...