Grayson Consulting, Inc. v. Wachovia Securities, LLC (In re Derivium Capital LLC)

Summarized by Kristen Siracusa , Office of the U.S. Trustee
12 years 9 months ago

Citation:

Grayson Consulting, Inc. v. Wachovia Securities, LLC (In re Derivium Capital LLC), No. 12-1518, --- F.3d --- (4th Cir. May 24, 2013)

Tag(s):

Ruling:

The Fourth Circuit affirmed the district court, first holding that the $161 million in stocks that customers transferred into the Wachovia brokerage accounts before Derivium's stock loan program collapsed were not transfers of debtor property and in no way diminished the bankruptcy estate as required for recovery pursuant to sections 544 and 548, as Derivium had no rights to the securities until after the transfers were effectuated. Secondly, the Fourth Circuit applied the "dominion and control" test to determine whether Wachovia qualified as the "initial transferee" for purposes of section 550. The Court affirmed the bankruptcy court's determination that Wachovia neither had nor exercised legal dominion and control over the customer transfers and was therefore not the initial transferee of the funds. The Court next found that the district court did not err in affirming the bankruptcy court's determination that Wachovia's commissions and fees were protected as "settlement payments" under section 546(e), the "stockbroker defense," once they were shown to be reasonable and customary in the industry. This conclusion is based on the plain language of section 546(e). Grayson also challenged the bankruptcy court's findings that Wachovia's low commissions were customary and reasonable. However, Grayson did not present any witnesses to rebut Wachovia's. Given that record, the Fourth Circuit found that the bankruptcy court did not clearly err in its determination. Next, Grayson contends that the bankruptcy court's protection of Wachovia's margin interest payments as "margin payments" under section 546 was in err. The bankruptcy court found that because accrued interest increases the total debt owed, margin payments reduce the deficiency in a margin account and qualify as "margin payments". Grayson's next argued that an exception to the stockbroker defense should be applied when it arises in the context of an alleged Ponzi scheme, as it would allow a broker to retail "ill-gotten profits" and undermine the "equitable goals" of the Code. The Court determined that the issue remained unanswered by the bankruptcy and district courts, and Grayson failed to convince the Court that it should establish an extra-statutory fraud exception to the stockbroker defense. Finally, the Court determined that Grayson, as assignee of the trustee, represents the bankruptcy estate and that the in pari delicto defense bars Grayson's tort claims against Wachovia. The Court distinguished the Seventh and Ninth Circuit cases that declined to apply the in pari delicto doctrine in bankruptcy cases, because both involved receivers, who unlike trustees, are not subject to section 541. Citing Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995); FDIC v. O'Melveny & Myers, 61 F.3d 17 (9th Cir. 1995). The Court stated that because Grayson stands in the shoes of Derivium, and Grayson's complaint alleged that Derivium engaged in alleged torts, Grayson is barred from suing Wachovia for those torts.

Procedural context:

Appeal from the United States District Court for the District of South Carolina, at Charleston. William O. Bertelsman, Senior District Judge, sitting by designation affirming the bankruptcy court's decision to grant summary judgment for Wachovia. The Fourth Circuit reviewed factual findings for clear error and legal conclusions de novo.

Facts:

Derivium Capital filed for relief under Chapter 11 after its stock loan lending program, alleged to be a Ponzi scheme, collapsed. The case was thereafter converted to Chapter 7. Grayson, the assignee of the Chapter 7 trustee, sought to recover assets transferred from customers of the Debtor into the Debtor's brokerage accounts at Wachovia and commissions, fees, and margin interest payments paid to Wachovia as fraudulent conveyances under sections 544 and 548 of the Bankruptcy Code. The Debtor's scheme involved Derivium customers transferring stocks to Derivium in exchange for 3 year non-recourse loans, worth 90% of the stocks' market values. When the loans matured, customers had the option to repay principal plus interest and recover the stock, surrender the stock, or refinance the loan. Customers were told that Derivium would hedge their collateral using a confidential, proprietary formula. Instead, Derivium's principals directed Wachovia to immediately transfer the stocks to other accounts and liquidate them. The proceeds were thereafter used to fund customers' loans and Derivium's owners' start-up ventures. The Debtor had difficulty satisfying its obligations when the loans matured, which ultimately resulted in the bankruptcy filing.

Judge(s):

King, Wynn, and Diaz, Circuit Judges

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