Appleton v. First Nat. Bank of Ohio

• Decision Date: 26 September 1995
• Docket Number: No. 93-4246,93-4246
• Citation: 62 F.3d 791
• Parties: Fed. Sec. L. Rep. P 98,843 William APPLETON, Trustee for the Liquidation of the Business of First Ohio Securities Company, Plaintiff-Appellant, v. FIRST NATIONAL BANK OF OHIO and Bank One, Akron, N.A., Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 791

62 F.3d 791

Fed. Sec. L. Rep. P 98,843

William APPLETON, Trustee for the Liquidation of the Business of First Ohio Securities Company Plaintiff-Appellant, v. FIRST NATIONAL BANK OF OHIO and Bank One, Akron, N.A. Defendants-Appellees.

No. 93-4246.

United States Court of Appeals Sixth Circuit.

Argued March 20, 1995.

Decided Aug. 10, 1995.

Rehearing Denied Sept. 8 and Sept. 26, 1995.

Carl E. Cormany (briefed), Mark V. Webber (briefed), Bernard Goldfarb (argued), Goldfarb & Reznick, Cleveland, OH, for William Appleton.

Marc B. Merklin (argued), John W. Solomon (briefed), Brouse & McDowell, Akron, OH, for First Nat. Bank of Ohio.

Donald W. Davis, Ronald N. Towne (argued and briefed), Guy, Lammert & Towne, Akron, OH, for Bank One, Akron, N.A.

Theodore H. Focht (briefed), Michael E. Don, Josephine Wang, Securities Investor Protection Corp., Gen. Counsel, Washington, DC, for amicus curiae Securities Investor Protection Corp.

Before: MILBURN and NELSON, Circuit Judges; JOINER, District Judge. ^*

JOINER, District Judge.

This case arises out of a Ponzi scheme operated by Thomas Gilmartin, the sole shareholder of First Ohio Securities Corporation (FOSC), and FOSC's president, Terence Zawacki. Gilmartin and Zawacki diverted funds intended by their customers to be invested by FOSC, into a bank account maintained by Gilmartin's sole proprietorship, First Ohio Investment Corporation (First Ohio Investment). Plaintiff, William Appleton, is the trustee appointed to liquidate FOSC under the Securities Investor Protection Act (Act), 15 U.S.C. Secs. 78aaa-78lll. Defendants are two banks, First National Bank of Ohio and Bank One, Akron, N.A., at which First Ohio Investment maintained accounts into which funds designated for investment by FOSC were deposited.

The trustee seeks to recover the wrongfully diverted funds from the banks, and proceeds in two distinct capacities. First, standing in the shoes of FOSC, the payee on checks and wire transfers deposited into First Ohio Investment's accounts, the trustee asserts claims of conversion and negligence against the banks. First National's alleged liability on these claims is $6 million, and Bank One's alleged liability is $204,000. Second, proceeding on behalf of the Securities Investor Protection Corporation as the equitable subrogee of customers who delivered to FOSC checks made payable to third parties, the trustee claims that the banks must repay the amount of those checks because they too were wrongfully deposited into an First Ohio Investment account. First National's alleged liability here is $175,000, and Bank One's alleged liability is $1900.

The district court entered summary judgment against the trustee on both claims. The court held, first, that Gilmartin's operation of FOSC and First Ohio Investment as essentially one entity made the two entities alter egos, barring the trustee's claims which were asserted on FOSC's behalf; and, second, that there is no right of subrogation to the claims of customers against parties other than the estate of the investment firm which is in liquidation. The trustee appeals both determinations. We reverse.

I.

As recounted by the Supreme Court, the history of the Securities Investor Protection Act dates back to the 1960s, when the securities industry experienced a business contraction that led to the failure or instability of numerous brokerage firms. Customers of these failed broker-dealers found their cash or securities on deposit dissipated or tied up in lengthy bankruptcy proceedings. Otherwise solvent broker-dealers that had open transactions with firms that had failed were threatened as well. "Congress enacted the [Securities Investor Protection Act] to arrest this process, restore investor confidence in the capital markets, and upgrade the financial responsibility requirements for registered brokers and dealers." Securities Investor Protection Corp. v. Barbour, 421 U.S. 412, 415, 95 S.Ct. 1733, 1736, 44 L.Ed.2d 263 (1975).

The Act created a new form of liquidation proceeding applicable to member firms, to ensure the completion of open transactions and the prompt return of customer property. Barbour, 421 U.S. at 416, 95 S.Ct. at 1736. In addition, the Act created the Securities Investor Protection Corporation (SIPC), a nonprofit membership corporation to which most registered broker-dealers are required to belong. 15 U.S.C. Sec. 78ccc(a). Finally, the Act required that the SIPC establish and maintain a "SIPC Fund" by levying assessments on its members. Sec. 78ddd. When necessary, the SIPC draws on this fund to satisfy the claims of the "customers" (as defined in the Act) of a bankrupt broker-dealer for cash or securities. The Act contemplates that customers' claims will be satisfied to the greatest extent possible from the assets of the bankrupt firm. The SIPC Fund supplements those assets, protecting customers' cash balances up to $100,000 and total cash and securities up to $500,000. Sec. 78fff-3; SIPC v. Ambassador Church Finance/Dev. Group, Inc., 788 F.2d 1208, 1209 (6th Cir.), cert. denied, 479 U.S. 850, 107 S.Ct. 177, 93 L.Ed.2d 113 (1986). In order to ensure the prompt payment of claims, the SIPC advances funds to the trustee for payment to customers. To the extent of its advances, the SIPC becomes subrogated to the claims of such customers. Sec. 78fff-3(a).

II.

FOSC, a licensed securities broker and dealer, was incorporated in 1985. Gilmartin was the sole shareholder and had the title of chairman of the board. Zawacki was the president and chief financial officer. FOSC appeared to observe the customary corporate formalities: it adopted by-laws, elected directors, and maintained a corporate minute book. The company was audited annually by a certified public accounting firm, which addressed its report to the board of directors. The record indicates, however, that Gilmartin and Zawacki controlled FOSC, and that their observance of corporate formalities was less than meticulous.

FOSC's by-laws originally provided for only one director, Gilmartin. This restriction later was lifted and seven board members purportedly were elected, one of whom was Zawacki. Gilmartin testified in a related proceeding, however, that "[t]here were never really any true directors," and that they "never had a formal board meeting" for FOSC. This testimony is corroborated by that of the supposed board members themselves. One, John Smith, denied knowing he was a board member, although he attended a meeting pertaining to FOSC's management. ¹ Two others testified that they knew they were board members, but only attended one meeting. The corporate minutes reflect that a number of board meetings were held between 1988 and 1990 at which Gilmartin, Zawacki and Smith were present; Smith denied having been present.

FOSC solicited customers for investment in certificates of deposit and the "All America Fund." Instead of making the promised investments through FOSC, Gilmartin diverted the would-be investors' money into First Ohio Investment bank accounts. Zawacki sent the customers fictitious statements in FOSC's name, and, when customers expected interest payments, Zawacki issued checks in FOSC's name but drawn from a First Ohio Investment account.

In November 1985, Gilmartin opened an account at First National in the name of First Ohio Investment, indicating that the account belonged to a partnership or a sole proprietorship, not a corporation. Between 1987 and June 1990, First National deposited $6 million in funds which were designated for payment to FOSC into the First Ohio Investment account. These deposits were made in two ways.

First National deposited a total of 165 checks made payable to FOSC, with a combined face value of approximately $3.1 million, into First Ohio Investment's account. Some of the checks so deposited bore no indorsement. Many were stamped with an indorsement which read, "First Ohio/For Deposit Only/50687886"; the account number given was for the First Ohio Investment account. Other forms of indorsement were used, including "For Deposit Only/First Ohio/50687886," "First Ohio/5068-7886" and simply "5068-7886." Only seven of the 165 checks so deposited bore an indorsement containing the words "First Ohio Securities." In addition, First National deposited into First Ohio Investment's account eleven other checks totalling approximately $275,000; these checks were made payable to persons other than FOSC, but delivered by would-be investors to FOSC for investment.

Wire transfers of funds intended for investment through FOSC were likewise deposited by First National into First Ohio Investment's account. Both FOSC and First Ohio Investment had executed wire transfer agreements, and these agreements reflected different addresses, account numbers and authorized persons. Customers directed wire transfers to First National with instructions to credit FOSC, but, apparently on Gilmartin's advice, included an account number that belonged to First Ohio Investment. A total of $2.9 million was transferred into First Ohio Investment's account in this fashion.

Gilmartin did not open a First Ohio Investment account with Bank One until April 1990, just two months before FOSC failed. FOSC did not have a Bank One account. When opening the Bank One account, Gilmartin indicated that First Ohio Investment was a corporation, but never supplied a corporate resolution approving the account. As he did with the First National account, Gilmartin caused checks made payable to FOSC and totalling $204,000 to be deposited into the Bank One First Ohio Investment account. Another check for $1900 was so deposited, but this one was made payable to a third party and delivered to FOSC for investment. Additionally, the parties state that Bank One deposited wire transfers naming FOSC into the First Ohio Investment account, but the amount of these transfers is not clear from the record.

The district court found, and the parties do not dispute,...