Determined not to hold a securities brokerage firm liable for fraudulent transfers in a Ponzi scheme case, the Fourth Circuit recently pushed the boundaries of fraudulent transfer law to affirm the lower court's dismissal of the trustee's claims against it. Grayson Consulting, Inc. v. Wachovia Securities, LLC (In re Derivium Capital LLC), 2013 U.S. App. LEXIS 10529 (4th Cir. May 24, 2013).
Although several aspects of the decision applied established case law, two holdings explored new territory. The court affirmed the dismissal of claims to recover securities transferred to Wachovia on the grounds that they were not transfers of property of the debtor. The court also affirmed the dismissal of claims to recover commissions on the grounds that the safe harbor provisions of § 546(e) protected those payments.
In Derivium's scheme, its customers were induced to transfer stocks in exchange for three-year non-recourse loans worth 90% of the stocks' market values. When the loans matured, customers had the option of repaying the principal plus interest and recovering the stock, surrendering the stock, or refinancing the loan for an additional term. Customers transferred their stocks into Wachovia brokerage accounts in Derivium's name. They were told that Derivium would hedge their collateral using a confidential, proprietary formula. Instead, Derivium's owners directed Wachovia to immediately transfer the stocks into other accounts and liquidate them. Derivium used the proceeds from the stock sales to fund customers' loans and start-up ventures of Derivium's owners.
Derivium collapsed when it could no longer satisfy its obligations to return customers' stocks and Wachovia closed its brokerage accounts. After Derivium filed bankruptcy, the trustee filed a complaint against Wachovia asserting several claims, including fraudulent transfer claims to recover $161 million in securities that customers transferred into the Wachovia brokerage accounts, and commissions that Derivium paid to Wachovia.
The Property Issue
The court found that the transfer of the customers' securities to an account in Derivium's name at Wachovia was not a transfer of Derivium’s property. The court stated:
The Commission Issue
This decision is also the first appellate decision to hold that commission payments can be shielded from recovery by the "settlement payment" defense of § 546(e).
The court reasoned:
Nevertheless, the could held, "commissions shown to be reasonable and customary parts of settling stock sales come within the stockbroker defense as 'settlement payments.'" Id. at 20. The court then affirmed the bankruptcy court's factual finding that Wachovia's discounted commission rates were reasonable and customary. Id. at *21.
The court did emphasize, however, that its holding does not apply to commissions that are "not part of the settlement of securities transactions, such as commissions paid for the solicitation of investors[.]" Id. at *19.
The Bottom Line
The Fourth Circuit's narrow view that the debtor's property did not include securities that collateralized loans from the debtor to its customers, coupled with the court's expansive view of the "settlement payment" defense, gives brokerage firms substantial new armor against trustee's fraudulent transfer claims in Ponzi scheme cases. Will other courts follow?