S.E.C. v. Credit Bancorp, Ltd.

• Decision Date: 09 May 2002
• Docket Number: Docket No. 00-6376.
• Citation: 290 F.3d 80
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, Stephenson Equity, Co., Intervenor-Plaintiff-Appellant, Robert Praegitzer, et al., Intervenors-Plaintiffs-Appellees, v. CREDIT BANCORP, LTD., et al., Defendants-Intervenors-Defendants, Carl H. Loewenson, Jr., Receiver-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

290 F.3d 80

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee Stephenson Equity, Co., Intervenor-Plaintiff-Appellant, Robert Praegitzer, et al., Intervenors-Plaintiffs-Appellees, v. CREDIT BANCORP, LTD., et al., Defendants-Intervenors-Defendants Carl H. Loewenson, Jr., Receiver-Appellee.

Docket No. 00-6376.

United States Court of Appeals, Second Circuit.

Argued: October 11, 2001.

Decided: May 9, 2002.

Donald L. Kahl, Hall, Estill, Hardwick, Gable, Golden & Nelson, P.C., Tulsa, OK (T. Lane Wilson, Tulsa, OK; William A. Maher, Frederick R. Kessler, Daniel S. Goldsmith, Wollmuth Maher & Deutsch, LLP, New York, N.Y. on the brief), for Intervenor-Plaintiff-Appellant.

Carl H. Loewenson, Jr., Morrison & Foerster, LLP, New York, N.Y. (Charles L. Kerr, Oliver Metzger, Andrew J. Fields, Eleonore Dailly, New York, N.Y., on the brief), for Receiver-Appellee.

Tom Karr, Securities and Exchange Commission, Washington, D.C. (David M. Becker, Gen. Counsel, Richard M. Humes, Assoc. Gen. Counsel, Melinda Hardy, Asst. Gen. Counsel, Meyer Eisenberg, Deputy Gen. Counsel, Washington, D.C., on the brief), for Plaintiff-Appellee.

Joel W. Sternman, Rosenman & Colin LLP, New York, N.Y.; Joel A. Mullin, Stoel Rives LLP, Portland, OR, submitted a brief for Intervenors-Plaintiffs-Appellees Robert Praegitzer, et al.

Before WALKER, Chief Judge, JON O. NEWMAN, and KEARSE, Circuit Judges.

JON O. NEWMAN, Circuit Judge.

The issue on this appeal is whether 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 purposes of a pro rata distribution to the defrauded victims. Stephenson Equity Company ("SECO") appeals from opinions and orders of the District Court for the Southern District of New York (Robert W. Sweet, District Judge), dated November 29, 2000, and January 19, 2001, the combined effect of which approved a distribution plan in the receivership of Credit Bancorp, Ltd. ("CBL") and modified an injunction freezing CBL's assets. SEC v. Credit Bancorp, Ltd., No. 99 CIV. 11395-RWS, 2000 WL 1752979 (S.D.N.Y. Nov.29, 2000) ("Credit Bancorp (Plan) I"); SEC v. Credit Bancorp, Ltd., 129 F.Supp.2d 259 (S.D.N.Y.2001) ("Credit Bancorp (Plan) II").¹ We conclude that a pro rata distribution was within the equitable discretion of the District Court, and we therefore affirm.

Background

SECO is a partnership substantially owned and controlled by Charles C. Stephenson, Jr. Stephenson is also founder and chairman of the board of Vintage Petroleum, Incorporated ("Vintage Petroleum"), a publicly traded oil and gas company. In March 1999, an agent of CBL contacted Stephenson to solicit SECO's participation in CBL's "insured credit facility program." Under this program, investors transferred cash or securities to CBL and received a promise of a quarterly dividend based on the value of the unencumbered assets transferred by the investor. The assets were to be used as collateral in the event that the investor drew upon a line of credit offered by CBL. The assets also served an additional purpose: in order to generate revenue from what CBL called "`riskless' arbitrage transactions" with European banks,<sup>2</sup> CBL reflected the assets off its normal balance sheet, and the shares transferred by the investors into CBL accounts increased the amount of off-balance sheet assets available to generate the "`riskless' arbitrage transactions."³ CBL implied that it would be able to pay the investors their promised dividends from the profits earned on the arbitrage transactions. In reality, CBL, running a classic Ponzi scheme, paid investors a return out of the assets transferred by later investors.

The SECO CFA and the SECO TEL. The principal documents executed in contemplation of the asset transfer were the "CBL Credit Facility Agreement" ("SECO CFA") and what the parties refer to as the "Trustee Engagement Letter" ("SECO TEL"). The SECO CFA was executed on June 22, 1999, by Stephenson, as general partner of SECO, Richard Blech, as President and CEO of CBL, Douglas C. Brandon, as Trustee, and J. Frederick Storaska, president of Corporate Executive Services, Inc., the managing general partner of SECO. It contemplated the transfer of eight million shares of SECO's Vintage Petroleum stock and a quarterly dividend to SECO of 1.25 percent of the value of the unencumbered assets. The SECO TEL was executed the same day by Blech, Brandon, and Storaska. The SECO TEL incorporated the terms of the SECO CFA.

According to the SECO CFA, "CBL will engage Douglas C. Brandon ... to act as Trustee, to hold the Assets [the eight million Vintage Petroleum shares] ... in a CBL account for the benefit of SECO and CBL." SECO CFA, ¶ 1.1; id. ¶ 2.1. SECO "will deliver to Trustee the specified fungible Assets ... to serve as collateral for the credit facility" and to be held by United States brokerage firms "for the Credit Bancorp Ltd. account." Id. ¶ 2.3. Under the same paragraph, however, "CBL ... retains the sole right to transfer some or all of the Assets to other Accounts...." Id.

"[B]eneficial ownership to the Assets shall at all times remain with SECO," id., ¶ 4.1, and "CBL and Trustee represent and warrant that the Trustee shall have legal title to the Assets and that SECO shall retain equitable title and beneficial ownership at all times, including following the deposit of the Assets into the Account, and that the Assets remain an asset of SECO and do not become an asset of CBL," id. ¶ 4.2.

The SECO TEL provides in relevant part:

I [Brandon] am the signing attorney-in-fact for all CBL Trustee accounts. These [Vintage] securities are to be held by me in a CBL account and may not be sold, pledged, assigned, margined, liened, hypothecated, or otherwise disposed of except as provided for in the CFA.... At no time am I to release the securities to any third party. As the securities are being delivered solely as collateral for any advance SECO may obtain under the credit facility with CBL, beneficial ownership is retained by SECO.

SECO's transfer of shares into CBL accounts. As described above, the SECO CFA provided that SECO would "deliver to Trustee the specified fungible Assets." ¶ 2.3 (Emphasis added). However, in a letter dated June 21, 1999, Stephenson authorized SECO's brokerage firm, Merrill Lynch, to transfer eight million shares of Vintage Petroleum into four separate CBL accounts, none of which was identified as a trust account. The first, at Alex Brown and Sons, is a CBL account identified by account number only. The second and fourth accounts, at Swiss American Securities, Inc. and Brown Brothers Harriman, respectively, are described as "FFC: [for further credit of] Credit Bancorp." The third account, with National Financial Services, is described as "FBO: [for benefit of] Credit Bancorp."

In early July 1999, CBL began transferring the Vintage shares out of the first group of accounts and into a variety of its other accounts at financial institutions such as Ameritrade, Charles Schwab, Chase Investment, and Credit Suisse Private Banking. None of these accounts was identified as a trust account. In both the first and subsequent groups of accounts, the investors' assets, including SECO's, were commingled with the assets of CBL's other investors.

CBL's fraudulent activity. CBL was operational from some time in 1997 until November 17, 1999, when the SEC filed suit and obtained a TRO freezing the assets of CBL and its related entities. By that time, CBL had victimized more than 200 investors. Most investors had transferred assets to CBL as contemplated by CFA and TEL agreements similar to those executed by SECO. Approximately 93 investors — referred to in this litigation as "the Bob Mann customers" — directed their deposits of cash and mutual funds under advice from Advisor's Capital Investments into the CBL "Insured Securities Strategy" program.

Contrary to its claims that it was engaging in "riskless" arbitrage, CBL's only material source of revenue was the deposit of cash and securities by its investors. CBL's primary business, other than attracting new investors, was to engage in currency futures and options trading that led to substantial losses. CBL financed its trading with cash and securities taken directly from its accounts and with money borrowed by pledging deposited securities as collateral for margin loans. CBL has encumbered a substantial portion of the securities deposited by customers, including a majority of the Vintage Petroleum shares, to secure its margin loans. CBL also used its investors' funds to pay the cash "dividends" to its investors, such as the dividends paid to SECO approximating $1.26 million dollars.

CBL shifted funds and securities regularly among brokerage accounts, and neither segregated customer deposits nor earmarked a particular customer's deposited assets to be used to pay that customer's custodial dividend. SECO's claim is distinguishable from that of many of CBL's customers only in that the eight million Vintage Petroleum shares it deposited were not converted to cash and are currently being held in CBL's brokerage accounts.⁴

The proposed plans of distribution and the District Court's approval. The District Court appointed a receiver, Carl H. Loewenson, Jr. ("the Receiver") to marshal CBL's assets and to prepare a distribution plan. Interim distribution plans were proposed by the Receiver, the SEC, and certain CBL customers as intervenors—SECO and Dr. Gene Ray (collectively the "SECO Intervenors") and Thomas Stappas et al. (the "Stappas Intervenors").⁵ Under SECO's proposed plan, those CBL clients, like SECO, who had executed CFAs, would be given priority over clients who had deposited cash directly into CBL accounts. Under the SEC's plan, the Receiver would liquidate all of CBL's assets—including the Vintage Petroleum shares in CBL's accounts—and distribute the resulting cash on a pro rata basis, based on...