SEC. INV. PROTECTION v. Stratton Oakmont, Inc.

• Decision Date: 07 May 1999
• Docket Number: Adversary No. 98-8459A.,Bankruptcy No. 97-8074A (TLB)
• Citation: 234 BR 293
• Parties: SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff, v. STRATTON OAKMONT, INC., Defendant. Harvey R. Miller, Esq., As Trustee For The Liquidation of Stratton Oakmont, Inc., Plaintiff, v. Daniel Porush, Nancy Porush, Jordan Belfort, Nadine Belfort a/k/a Caridi, JRB Group, Inc., RMS Network, Inc., and Maxwell Belfort, Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

234 B.R. 293 (1999)

SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff, v. STRATTON OAKMONT, INC., Defendant.

Harvey R. Miller, Esq., As Trustee For The Liquidation of Stratton Oakmont, Inc., Plaintiff, v. Daniel Porush, Nancy Porush, Jordan Belfort, Nadine Belfort a/k/a Caridi, JRB Group, Inc., RMS Network, Inc., and Maxwell Belfort, Defendants.

Bankruptcy No. 97-8074A (TLB), Adversary No. 98-8459A.

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

May 7, 1999.

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Weil, Gotshal & Manges, L.L.P., New York City, by Steven Alan Reiss, Curt P. Beck, Theodore E. Tsekerides, for Harvey R. Miller, as Trustee for Stratton Oakmont, Inc.

Ormsten & Evangelist, Jericho, New York, by Franklin D. Ormsten, for defendant Maxwell Belfort.

Andrews & Kurth, L.L.P., New York City, by Lynne M. Fischman Uniman, Jennifer L. Sulzberger, Paul N. Silverstein, Laurence E. Wiseman, for defendant Nancy Porush.

Murray & McCann, Rockville Centre, New York, by Joseph D. McCann, William J. Kelleher III, for defendant Nadine Belfort.

Phillips, Lytle, Hitchcock, Blaine & Huber, L.L.P., New York City, by Leon C. Marcus, William M. Rossi-Hawkins, Michael J. DiLeo, for Daniel M. Porush.

Bodian & Eames, L.L.P., New York City, by Robert I. Bodian, Burton S. Weston, Great Neck, New York, by Burton S. Weston, for Jordan Belfort and JRB Group, Inc.

OPINION ON MOTION TO DISMISS

TINA L. BROZMAN, Chief Judge.

The defendants in this adversary proceeding move to dismiss certain of the claims asserted against them for failure to plead fraud with particularity pursuant to Federal Rule of Civil Procedure ("F.R.C.P.") 9(b) and failure to state a claim upon which relief can be granted pursuant to F.R.C.P. 12(b)(6), both made applicable to this adversary proceeding by Federal Rule of Bankruptcy Procedure ("F.R.B.P.") 7009 and 7012, respectively. The facts are drawn, as they must be on a motion of this sort, from the allegations of the complaint.

I. Background

On January 24, 1998, (the "commencement date") Stratton Oakmont, Inc. ("Stratton") filed a petition for reorganization pursuant to Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code"). Upon application of the Securities Investor Protection Corporation ("SIPC"), the District Court for the Southern District of New York stayed the Chapter 11 proceedings, appointed Harvey R. Miller, Esq. as the liquidation trustee (the "Trustee") pursuant to the Securities Investors Protection Act of 1970 ("SIPA") and removed the liquidation proceeding ("SIPA Proceeding") to this court. In accordance with the statutory mandate, this SIPA proceeding is being conducted, to the extent not inconsistent with SIPA, as a liquidation proceeding under Chapters 1, 3, 5 and Subchapters I and II of Chapter 7 of the Bankruptcy Code. See 15 U.S.C. § 78fff(b).

The Trustee commenced an adversary proceeding on May 13, 1998, against Daniel Porush and his wife, Nancy (collectively the "Porushes"); Jordan Belfort ("Belfort") and his wife, Nadine (collectively the "Belforts"); Belfort's father, Maxwell Belfort ("Maxwell"); JRB Group, Inc. ("JRB"), and RMS Network, Inc. ("RMS"). The gravamen of the Trustee's Complaint is a fraudulent scheme principally orchestrated by Belfort and Porush, with the help of their wives and Belfort's father, to strip Stratton and its creditors of whatever assets and income stream Stratton had to offer. Central to the Trustee's theory are: 1) the "Stock Purchase" and "Non-Compete" Agreements (the "SP" and "NCP Agreements," respectively) and the payments made to Belfort pursuant thereto (the "SP" and "NCP Payments"), and 2) the payment of excessive salaries and bonuses to Porush (the "S & B Payments"), all of which either rendered Stratton insolvent or occurred while Stratton was already insolvent.

The Complaint contains thirteen claims for relief. The first four are premised on actual and constructive fraud pursuant to New York Debtor and Creditor Law ("DCL") §§ 270-281 and §§ 544(b) and 550(a) of the Bankruptcy Code.¹ The Fifth through Seventh Claims are for breach of fiduciary duty and are not the subject of these dismissal motions. The remaining five claims are grounded in common law or equity² or in § 720 of the New York Business Corporation Law ("BCL"), which allows recovery for breach of fiduciary duty. The Complaint seeks primarily to recover from the defendants the SP, NCP and S & B Payments as fraudulent transfers, and secondly, to recover damages for the losses incurred through the unlawful diversion of Stratton's assets.

A. Stratton's Management

Stratton, a general securities brokerdealer with executive offices in Lake Success, New York, was wholly-owned by its parent and alleged alter ego, RMS. See Adversary Proceeding Complaint, at ¶¶ 30-32 (all citations to the Complaint are referred to as "¶ ___"). RMS is a shell corporation with no other purpose than to own 100% of the shares of Stratton. ¶ 31. RMS and Stratton maintained the same office space, telephone lines, corporate records and documents, as well as the same officers, directors, and shareholders. ¶ 32. Up until March 10, 1994, both Porush and Belfort were officers and directors of Stratton and RMS³, (¶¶ 23, 25), holding the lion's share of the RMS stock. ¶ 31.

Stratton was grossly mismanaged by Belfort and Porush, (¶¶ 41-45), leading to its insolvency. ¶ 41. In March 1992, the Securities and Exchange Commission ("SEC") charged both of them, as principals of Stratton, with market manipulation and fraudulent acts and practices relating to the offer and sales of securities. ¶¶ 42-44. In 1993, Belfort and Porush decided to negotiate a Consent Order with the SEC ("SEC Consent Order"). ¶ 45. On August 13, 1993, Belfort resigned as President of Stratton and was immediately replaced by Porush. ¶ 46. Notwithstanding this resignation, Belfort continued to hold himself out and to receive compensation as an "officer" of Stratton. ¶ 51. He also remained a director of Stratton and, with Porush's help⁴, authorized Stratton to pay himself large bonuses totaling over $1,400,000 between late 1993 and early 1994, all of which are reflected in Stratton's books and records. ¶¶ 47-48. While Porush scratched Belfort's back, so the theory goes, Belfort scratched Porush's by co-authorizing over $600,000 in bonuses payable to Porush during the same time period. ¶ 50.

By February 1994, the terms of the SEC Consent Order had been hammered out; Belfort would be barred from the securities industry for life and Porush was to be suspended from serving in any supervisory capacity at Stratton for one year. ¶¶ 52, 79. Aware of what the future held in store, on February 10, 1994, Belfort resigned as a director of Stratton. ¶ 53. Taking advantage of that vacant director's position, Porush elected himself President of Stratton for a second time, increasing his salary 100% from $720,000 to $1,560,000 per annum. ¶ 53. On March 17, 1994, Porush and Belfort agreed to the terms of the SEC Consent Order. ¶ 55.

B. The Alleged Fraudulent Transfers

With the knowledge of the impending SEC Consent Order and its effect, Porush and Belfort directed the preparation of the SP and NCP Agreements, (¶ 56), whose simultaneous execution was also part of the plan to strip Stratton of its assets. ¶¶ 10, 11. Both agreements were to be funded by Stratton. ¶ 12. On March 10, 1994, only one week before the SEC Consent Order was to become effective, Porush and Belfort entered into the SP and NCP Agreements. ¶ 61. The former provided that Belfort would sell his 47.5% of the common stock of RMS to Porush for $1,200,000 (plus interest at 3.65%), which was to be paid in 36 equal monthly installments of $35,242.25 from March 15, 1994, to February 15, 1997. ¶ 57; see Exhibit A annexed to the Complaint. Porush then became the 95% shareholder of RMS. ¶ 31. The latter agreement was executed by Belfort, Porush and RMS and provided that RMS would pay Belfort and JRB (in the event of Belfort's death) $180,000,000 for 1) a covenant not to compete with RMS for fifteen years and 2) a promise to introduce certain investment banking business to RMS. ¶ 58; see Exhibit A annexed to the Complaint. Under this second agreement, payments of one million dollars were scheduled to be made to Belfort every month beginning on March 15, 1994, and ending on February 15, 2009. ¶ 58. The Trustee treats the SP and NCP Agreements as the foundation of the defendants' scheme to defraud and loot Stratton. Looking at everything accomplished by the simultaneous execution of and real parties in interest to both agreements, Porush gained complete control of Stratton by acquiring Belfort's 47.5% share of RMS (because RMS owned 100% of Stratton) in exchange for having Stratton pay Belfort $1,200,000 up front and $180,000,000 over time.

Although RMS is the obligee under the NCP Agreement, the Trustee pleads that RMS was but a conduit since Stratton was advancing the needed funds to RMS to pay Belfort. ¶¶ 12, 13, 58, 74 and 76. It is also the NCP Agreement which, the Trustee maintains, if Stratton was not already insolvent, rendered Stratton insolvent. ¶¶ 13, 39. Stratton's then corporate counsel advised Porush and Belfort that the agreements were defective and recommended that Stratton not enter into them. ¶ 59. Needless to say, in light of their execution, that advice was ignored. ¶ 60.

The Trustee alleges that these agreements were patently fraudulent and lacked consideration because they contained valuations of Stratton and RMS that were completely inconsistent and unrealistic. ¶¶ 63-64. The SP Agreement effectively valued RMS at $2,500,000, roughly twice what Porush paid Belfort for his 47.5% share in RMS. ¶ 64....