Rochlis v. United States

• Decision Date: 14 January 2020
• Docket Number: No. 16-200T,No. 16-201T,No. 16-210T,16-200T,16-201T,16-210T
• Parties: JON A. ROCHLIS, ANNE R. LAVIN, JON ROCHLIS AS EXECUTOR OR THE ESTATE OF IRENE M. ROCHLIS (AKA WARREN), KENNETH ISHII, and SHERYL A. ISHII, Plaintiffs, v. UNITED STATES, Defendant.
• Court: U.S. Claims Court

JON A. ROCHLIS, ANNE R. LAVIN, JON ROCHLISAS EXECUTOR OR THE ESTATE OF IRENE M. ROCHLIS (AKA WARREN),KENNETH ISHII, and SHERYL A. ISHII, Plaintiffs, v. UNITED STATES, Defendant.

No. 16-200T

No. 16-201T

No. 16-210T

United States Court of Federal Claims

January 14, 2020

Trial; Tax; Federal Tax Deductions; Theft Loss; 165 U.S.C. § 165; Treas. Reg. 1.165; State law; Constructive Sale.

Brian G. Isaacson, Isaacson Law Firm, Seattle, WA for plaintiffs.

Benjamin C. King, Jr., Trial Attorney, Department of Justice, Tax Division, Court of Federal Claims Section, Washington, D.C., for the defendant. With him were Mary M. Abate, Assistant Chief, Court of Federal Claims Section, David I. Pincus, Chief, Court of Federal Claims Section, and Richard E. Zuckerman, Principal Deputy Assistant Attorney General, Tax Division, United States Department of Justice.

OPINION

HORN, J.

The plaintiffs, Jon A. Rochlis, Anne R. LaVin, Jon Rochlis as Executor of the Estate of Irene M. Rochlis (aka Warren), Kenneth Ishii, and Sheryl A. Ishii, filed complaints in the United States Court of Federal Claims, seeking a tax refund from an alleged theft loss in 2009 as a result of the purported investments by Derivium Capital, LLC (Derivium). After all plaintiffs filed claims for refund with the Internal Revenue Service (IRS) in 2013 for the tax year 2009, all plaintiffs subsequently filed complaints in each of the above captioned cases. The complaints and amended complaints in Case Nos. 16-200T, 16-201T, and 16-210T are substantially similar except for the amounts plaintiffs allege they lost due to the theft at issue and the amount they seek to recover.¹ A three day trial was held andpost-trial briefings on the legal and factual issues raised in these cases were filed by all parties. After review of the transcripts, the testimony, the exhibits entered into the record and the submissions subsequently filed by the parties, the court makes the following findings of fact.

FINDINGS OF FACT

Derivium Capital

The parties stipulate² that Charles Cathcart, "a Ph.D. economist, developed the concept for a 90% stock loan program in 1997, and in the same year began promoting a variety of 90% Loan products through FSC First Security Capital (Texas), which he co-owned with several individuals, including Kenneth Calvert, David Kekich, Rob Rawlings, and Clifford Lloyd." (internal references omitted). The joint stipulations provide that "[i]n 1998, [Charles] Cathcart relocated the 90% Loan Program to Charleston, South Carolina in order to exercise more control over it. In Charleston, [Charles] Cathcart formed First Security Capital, LLC ('FSC'), and thereafter FSC Texas ceased operations." According to the joint stipulations, Charles Cathcart held a 50% ownership interest in FSC and he served as President. The joint stipulations indicate that "[e]ffective January 1, 2000, FSC's name was changed to Derivium Capital, LLC," and "Derivium eventually bought out Lloyd, Calvert, Rawlings and Kekich's interests. By 1998, ownership of FSC was allocated as follows: [Charles] Cathcart 50%, [Yurij] Debevc 25% and Scott [Cathcart] 25%."³"Throughout its operation, virtually all of Derivium's business consisted of the marketing and administration of the 90% Loan Program."

The joint stipulations make clear that

[t]he 90% Loan Program was marketed as a way for customers to: (a) obtain the benefit of cash in an amount equal to 90% of the value of their securities; (b) defer paying capital gains on the transaction; and (c) be protected against the risk that the securities would depreciate while at the same time preserving their ability to take advantage of any possible appreciation in the securities' value.

The parties also stipulate that

Derivium's marketing materials emphasized the customer's ability to recover their securities at the end of the transaction term, stating that the customer would "retain beneficial ownership" of his securities, such that "if your equities increase in value, you keep all the upside," and "[b]ecause you still own your stocks, you retain all the potential for further gains." These statements were false, since Derivium sold its customers' securities prior to the inception of the transaction.

(alternation in original). The joint stipulations indicate that "[u]pon Derivium's receipt of the securities, in every case, the securities were immediately sold." The parties also stipulate that:

The marketing materials state that Cathcart[⁴] is a "world-recognized expert in building and preserving wealth for clients through the application of sophisticated hedging strategies," whose "proprietary structures and models are the foundation of the products offered through Derivium Capital." Derivium's marketing materials also state that Derivium will engage in "hedging" transactions to protect the value of customers' securities. These statements were also false. Derivium never engaged in hedging transactions. Rather, it simply sold its customers securities, remitted an amount equal to 90% of the proceeds back to its customers, and kept the remaining 10% for its own purposes, including paying operating expenses and fees to its owners.

The joint stipulations of fact point to an obvious untruth. According to the parties' joint stipulation of facts:

Following the sale of a customer's securities, however, Derivium and the supposed lenders faced a countervailing risk, which was that stock values would rise. Because customers' securities were immediately sold in every case, if a customer elected under the MLA[⁵] to recover his securities at the end of the transaction term, Derivium had to repurchase the securities on the open market to return those shares to the customer.

The parties' joint stipulation of facts also indicate that "[i]n the event that prices for more than a few of the securities submitted as collateral increased substantially during the transaction term, Derivium faced an inherent risk of being unable to satisfy the obligations to customers. Despite this known risk, Derivium never engaged in hedging transactions."

In total, "[t]he 90% Loan Program generated approximately 3100 transactions, totaling more than $1 billion in sale proceeds, 90% of which was used to fund the purported loans to customers, leaving at least $100 million as the difference between the purported loan proceeds and the value of the securities (the 'Net Proceeds')." The joint stipulations continue: "Derivium used the Net Proceeds for a variety of purposes. First, Derivium (and later Derivium Capital USA and Veridia) kept approximately 20 to 25% of the Net Proceeds for itself in the form of commissions. Throughout its operation, Derivium's only significant source of income was commissions from the sale of customer's securities." The stipulations provide that "[t]he bulk of the Net Proceeds (approximately $45 million) was used to fund various start-up companies owned indirectly by [Charles] Cathcart, [Yurij] Debevc and Scott [Cathcart] and located in Orangeburg and Summerville, South Carolina (the 'Start-Up Companies')." According to the joint stipulations: "The purported 'hedging' model implemented by Cathcart involved the immediate sale of the customer's securities and investment of the Net Proceeds into Start-Up companies owned and controlled by the Principals," and "[i]n fact, the provision of funds to the Start-Up Companies did not constitute a genuine hedge, but rather was nothing more than a speculative gamble." "To adequately and truly hedge Derivium's risks related to the 90% Loan Program, Derivium would have had to purchase call options correlated with its customers' securities. In fact, the Net Proceeds from the 90% Loan Program would have been insufficient to purchase adequate call options," and moreover, "Derivium did not maintain reserves of capital that could be drawn upon if the supposed 'hedges' failed."

As early as 2001, Derivium began defaulting on its obligations to its clients when the first transactions engaged in by Derivium in 1998 began maturing. According to the parties' joint stipulations, "Derivium defaulted because Derivium had no genuine hedges in place, had no reserves, and the proceeds from new 90% Loan transactions wereinsufficient to allow Derivium to purchase the replacement securities on the open market for those customers who did seek a return of their highly appreciated stocks." "At the end of 2002, Cathcart ceased marketing and administering securities transactions through Derivium due to litigation by customers whose securities Derivium had failed to return at maturity and due to an investigation by the California Department of Corporations." "Derivium's operations were then assumed and divided among two new entities. Derivium USA, which is wholly-owned by Cathcart, assumed all marketing and sales functions for the 90% Loan Program. Veridia Solutions, LLC which is wholly-owned by Debevc, performed the related administrative functions."⁶

The joint stipulations indicate that "[o]ver the next few years, Derivium racked up tens of millions of dollars in judgments from defaults - yet Cathcart and his co-promoters continued to market and administer the 90% Loan Program."⁷ Also according to the joint stipulations, "[b]y 2008, Derivium's failure to perform on its obligations resulted in claims against Derivium totaling approximately $150 million."

The parties in the above captioned cases stipulate that "the claim that the 90% Loan Program involved 'hedging' is false or fraudulent. No funds were used to hedge any 90% Loan transactions. Cathcart's claim that the use of the 90% Loan proceeds . . . constituted hedges against securities was pure fiction and constituted nothing more than an economic gamble." The joint stipulations continue:

The claim that 90% Loan transactions are non-taxable loans is a false statement. Derivium and/or the purported lender immediately sold the customers' securities at the inception of the transaction - and thus representations that the securities

...