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

• Decision Date: 06 April 2001
• Docket Number: No. 99 CIV. 11395(RWS).,99 CIV. 11395(RWS).
• Citation: 138 F.Supp.2d 512
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Stephenson Equity Company, Plaintiff-Intervenor, v. CREDIT BANCORP, LTD., Credit Bancorp, Inc., Richard Jonathan Blech, Thomas Michael Rittweger and Douglas C. Brandon, Defendants. Carl H. Loewenson, Jr., Esq., as Receiver for Credit Bancorp, Ltd., Credit Bancorp, N.V., and their subsidiaries and affiliated entities, Third-Party Plaintiff, v. Certain Underwriters at Lloyds, London, London Market Companies, Gulf Insurance Company, and Federal Insurance Company, Third-Party Defendants.
• Court: U.S. District Court — Southern District of New York

Page 512

138 F.Supp.2d 512

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Stephenson Equity Company, Plaintiff-Intervenor, v. CREDIT BANCORP, LTD., Credit Bancorp, Inc., Richard Jonathan Blech, Thomas Michael Rittweger and Douglas C. Brandon, Defendants.

Carl H. Loewenson, Jr., Esq., as Receiver for Credit Bancorp, Ltd., Credit Bancorp, N.V., and their subsidiaries and affiliated entities, Third-Party Plaintiff, v. Certain Underwriters at Lloyds, London, London Market Companies, Gulf Insurance Company, and Federal Insurance Company, Third-Party Defendants.

No. 99 CIV. 11395(RWS).

United States District Court, S.D. New York.

April 6, 2001.

COPYRIGHT MATERIAL OMITTED

Securities and Exchange Commission, Salt Lake City, UT, By Thomas M. Melton, Of Counsel, for Plaintiff.

Securities and Exchange Commission, New York City, By Robert Blackburn, Of Counsel, Local Counsel.

Honorable Mary Jo White, United States Attorney for the Southern District of New York City, Attorney for Intervenor United States of America, New York City, By Edward Chang, Assistant U.S. Attorney, Of Counsel, for Plaintiff-Intervenors.

Morrison & Foerster, Attorney for Receiver, New York City, By Andrew J. Fields, Oliver Metzger, Of Counsel, for Receiver.

OPINION

SWEET, District Judge.

Carl H. Loewenson, Jr. ("Loewenson"), the court-appointed receiver (the "Receiver") for defendant Credit Bancorp, Ltd. and related entities (collectively, "Credit Bancorp") has moved for an order declaring that Credit Bancorp's customers have priority over the United States (the "Government") and the States for payment from certain property (the "Protected Property") that is either currently in the receivership estate or is anticipated will be brought into that estate, pursuant to 28 U.S.C. § 2410(a)(1) and 28 U.S.C. § 1340, and declaring that in notifying the Court and the United States of the potential for tax liability the Receiver has discharged his obligations pursuant to 31 U.S.C. § 3713(b) and may not be held liable for effectuating a court-ordered plan of partial distribution of assets in the receivership estate. For the reasons set forth below, the motion is granted in part and denied in part.

Prior Proceedings

This action commenced on November 17, 1999, with the filing of a complaint by the Securities and Exchange Commission (the "SEC") against Credit Bancorp and its principals. The Court appointed Loewenson as Fiscal Agent for Credit Bancorp by order of November 23, 1999, and appointed him as Receiver for Credit Bancorp by order of January 21, 2000 (the "Order Appointing Receiver").

The Order Appointing Receiver directed the Receiver inter alia to marshal Credit Bancorp's assets. The order also directed the Receiver not to sell any securities and not to return to Credit Bancorp customers any securities or other assets deposited with Credit Bancorp, or into an account in the name of Credit Bancorp, without further order of this Court.

The Government was brought into this action in its capacity as the Internal Revenue Service (the "IRS") on November 8, 2000, when an initial motion (the "November 8 Motion") by the Receiver for a determination of priority was served on the Office of the United States Attorney for the Southern District of New York.¹

By opinion dated November 29, 2000, SEC v. Credit Bancorp, Ltd., 2000 WL 1752979 (S.D.N.Y. Nov.29, 2000) [hereinafter, "Credit Bancorp X"], opinion dated January 19, 2001, SEC v. Credit Bancorp, 129 F.Supp.2d 263 (S.D.N.Y.2001), and order dated January 19, 2001, the Court approved a plan of partial distribution of the receivership assets. The plan provides for what is in essence a pro rata return of customer-deposited property to the Credit Bancorp customers, either in the form of their deposited property, i.e., securities (where that property is under the Receiver's control), or in the form of cash or replacement securities (where the deposits were stolen, are missing, or are in securities accounts not under the Receiver's control). The plan requires customers to whom deposited securities are returned to make a cash "Undertaking" payment. The Undertaking proceeds are to be used to pay or secure Credit Bancorp's margin debts, to make a distribution to customers whose deposits were converted, and to provide for the ongoing cash needs of the Receivership. Implementation of the plan is subject to either a stipulation or an order by this Court granting the relief requested in the instant motion.

Subsequent to the filing of the November 8 Motion, the Receiver and the Government began negotiations regarding the subject of Credit Bancorp's tax liability, and the motion was ordered off the calendar on February 7, 2001. On February 28, 2001, the Receiver and the Government entered into a stipulation and order (the "Stipulation") which resolved certain tax matters but left others unresolved.

In the Stipulation, the Government agreed not to assert a federal tax lien for any tax "owed by Richard Blech or any other defendant" against the assets to be distributed pursuant to the plan of partial distribution. The Government further agreed that the Receiver would not be personally liable as a consequence of proceeding with the plan for such tax liability accruing before the Receiver's appointment on January 21, 2000. The Government specifically reserved its right, however, to assert a tax lien or to assert priority as to income generated by estate assets after January 21, 2000 (the "Post-Receivership Income"), any future insurance proceeds, any securities held in accounts in the name of Credit Bancorp that are not specifically identifiable as customer-deposited securities, and any asset, property, or rights to property of defendant Richard Jonathan Blech ("Blech"). The Government also reserved its right to seek to hold the Receiver personally liable for tax liability based on such income or assets.

By motion of March 1, 2001 (the "March 1 Motion") the Receiver renewed the motion for a determination of priority with respect to those not resolved by the Stipulation. Submissions were received, and the matter was marked fully submitted on March 28, 2001.²

Facts

The following facts are gleaned from the declarations, exhibits, and other submissions to the Court.³ These submissions include inter alia extensive evidence regarding the operations of Credit Bancorp.⁴

Credit Bancorp operated a fraudulent investment or "Ponzi" scheme prior to the filing of this suit by the SEC. Credit Bancorp solicited customers to deposit securities, cash, and other assets with the promise of a return in the form of a "custodial dividend" based upon a percentage of the market value of the deposits or, in the case of certain customers, to invest the customers' cash and mutual funds at above-market rates in mutual funds to be managed by Credit Bancorp.⁵ Credit Bancorp represented to customers that it engaged in "riskless arbitrage" trading. At least two hundred customers took Credit Bancorp up on this offer of a "riskless" investment opportunity.

The marketing materials distributed by Credit represented and the underlying contracts entered into between Credit Bancorp and the customers provided that deposits were to be held in trust under the control of a designated trustee and were insured by Lloyds of London. Customers were specifically advised that the deposits were not the property of Credit Bancorp and that creditors of Credit Bancorp would have no recourse to the property.

Typically, customers executed two documents when they placed their deposits with Credit Bancorp: (1) a Credit Facility Agreement (the "CFA"); and (2) a Trustee Engagement Letter (the "Trustee Letter").⁶ Both of these documents provided that the deposits would be held in trust, that equitable title remained with the customer, and that Credit Bancorp's sole interest in the deposit was as collateral in the event the customer borrowed from Credit Bancorp. Thus, a model CFA, included in Credit Bancorp's marketing materials, specifically provided that Credit Bancorp had a security interest in the "collateral" to be held by the "Trustee," Model CFA ¶ 2.5, and that the Trustee would not "at any time sell, trade or otherwise dispose of the Collateral, except as expressly authorized" in the agreement, id. ¶ 4.1. Under the model CFA, Credit Bancorp had a security interest in the collateral only to "secure the repayment of an `Advance,'" which is defined as a payment to the customer from Credit Bancorp under the "credit facility." Id. ¶¶ 2.4, 2.5. Only twelve Credit Bancorp customers are indebted to Credit Bancorp for a loan made pursuant to this arrangement.

The model Trustee Letter conformed in all material respects with the model CFA. Under the Trustee Letter, the "Trustee" was specifically "engaged" with regard to the transaction set forth in the Credit Facility Agreement. Model Trustee Letter at 1. The letter stated: "As the signing officer for all Credit Bancorp Ltd. trustee accounts, I represent on behalf of Credit Bancorp Ltd. and myself that the securities, as held by me in the account, are not an asset of Credit Bancorp Ltd." Id. The Trustee Letter further provided that:

These securities are to be held in a Credit Bancorp Ltd. account and may not be sold or otherwise disposed of except as provided for in the [Credit Facility Agreement]. In the case of a creditor claim against Credit Bancorp and an attempt to seize the securities, I am instructed to immediately return the securities to you. At no time am I to release the securities to any third party. As the securities are being delivered as collateral for the implementation of the credit facility with Credit Bancorp, title is held by you.

Id.

Although certain details of the CFA and Trustee Letter differed from customer to customer as the result of individual negotiations, they share the following essential elements: (1) they created an express trust; (2) the customer deposits were to be held in accounts in...