Anniе BERMAN and Edward Berman, Plaintiffs-Appellants, v. MORGAN KEEGAN & CO., INC., Defendant-Appellee,
No. 11-2725-cv.
United States Court of Appeals, Second Circuit.
Jan. 19, 2012.
Scott E. Zweigel, Parker, Hudson, Rainer & Dobbs, LLP, Atlanta, G.A. (G. Wayne Hillis Jr., Parker, Hudson, Rainer & Dobbs, LLP, Atlanta, G.A., Ronald S. Herzog, Robinson, Brog, Leinwand, Greene, Genovese & Gluck, P.C., New York, N.Y., on the brief), for Defendant-Appellee.
Present: ROBERT A. KATZMANN, GERARD E. LYNCH, Circuit Judges, LEWIS A. KAPLAN, Distriсt Judge.*
SUMMARY ORDER
Plaintiffs-Appellants Annie Berman and Edward Berman appeal a March 18, 2011 judgment entered by the U.S. District
Plaintiffs allege that they were victims of a wide-ranging fraudulent scheme orchestrated by Charles Cathcart, a principal at Derivium Capital LLC. (“Derivium“).1 Under the guise of a tax deferral transaction, Derivium took plaintiffs’ securities and purported to “loan” back to plaintiffs an amount equivalent to 90% of the value of those securities. Moreover, over the course of the loan term, Derivium represented to plaintiffs that, through Derivium‘s management, plaintiffs’ securities portfolio continued to receive interеst payments. In theory, this allowed plaintiffs to monetize 90% of their securities’ value while deferring payment of capital gains taxes. In reality, however, plaintiffs allege that Derivium sold their securities at the outset, conveyed 90% of the proceeds from that sale back to plaintiffs in the form of a sham “loan,” and funneled the remaining 10% of the money into Cathcart‘s personal business ventures. As a result, plaintiffs now owe the Internal Revеnue Service over $1 million in back taxes and penalties.
Cathcart‘s scheme has been the subject of extensive litigation. See, e.g., Nagy v. United States, Nos. 2:08CV2555(DCN), 2:08CV2755(DCN), 2009 WL 5194996, *1–2 (D.S.C.2009) (finding Derivium‘s officers and directors subject to penalties under
We review de novo a district court‘s dismissal of a complaint for failure to state a claim. S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 103-04 (2d Cir. 2009). In order to state a claim under
Moreover, in diversity cases alleging fraud,
We turn first to the plaintiffs’ contention that the district court erred in holding that the Complaint failed to allege sufficient facts to support a strong inference that Morgan Keegan had actual knowledge of Derivium‘s fraudulent scheme. In this regard, plaintiffs make four arguments on appeal: (1) that the presence of a document in Derivium‘s Morgan Keegan account filеs describing how Derivium marketed the 90% Loan Program establishes that Morgan Keegan knew that Derivium customers’ collateral was supposed to be “hedged” and not sold; (2) that Morgan Keegan was obligated by “Know Your Customеr Rules” to closely monitor Derivium‘s operations, and so one can infer that it did so; (3) that Morgan Keegan assisted Derivium‘s sale of plaintiffs’ collateral before Derivium was authorized to do so under the MLFSAs, and therefоre must have known of Derivium‘s fraud; and (4) that one can infer from Morgan Keegan‘s entering into an release agreement with Derivium that Morgan Keegan was aware of Derivium‘s fraud. We find each of these arguments unconvincing.
First, Morgan Keegan‘s understanding as to how Derivium marketed and sold the 90% Loan Program to its customers has no direct bearing on whether Morgan Keegan knew that scheme was fraudulent. Moreover, the parties’ loan аgreements expressly granted Derivium, as the “Lender,”
the right and power, without the requirement of notice or consent of [the plaintiffs], to assign, transfer ... lend, encumber, short sell, sell, sell outright and/or otherwise dispose of some or all of the Collateral during the Loan Term
Annie Berman et al. v. Morgan Keegan & Co., Inc., No. 10CV5866 (PKC), 2011 WL 1002683, at *11 (S.D.N.Y. March 14, 2011). Accordingly, the mere fact that Derivium sold plaintiffs’ securities would not have put Morgan Keegan on notice of Derivium‘s fraud.
Second, Morgan Keegan‘s “Know Your Customer” obligations are, standing alone, far from sufficient to support a strong inference that it had actual knowledge of Derivium‘s fraud. As an initial matter, plaintiffs do not identify any particular monitoring obligation on the part of Morgan Keegan, the proper exercise of which would have alerted it to Derivium‘s fraud. Moreover, even if such an obligation were to be identified, the strongest inference one could draw therefrom is that Morgan Keegan should have known of Derivium‘s wrongdoing, not that it had actual knowledge thereof. Otherwise, brokerage firms would be liable for aiding and abetting fraud every time a fraudster used broker-
Third, the mere fact that Derivium sold its customers’ securities outside of the “loan term” is insufficient to support a strong inference that Morgan Keegаn was actually aware of Derivium‘s fraud. Critically, the Complaint alleges no facts by which we could infer that Morgan Keegan knew when Derivium was authorized to sell plaintiffs’ collateral under the loan agreements. Aсcordingly, there is nothing in the Complaint from which we can infer that the timing of Derivium‘s sales of plaintiffs’ securities should have been cause for concern.
Finally, the fact that Morgan Keegan entered into an agreement with Derivium by which Derivium relieved Morgan Keegan of any “best execution” brokerage obligations does not support an inference that Morgan Keegan knew Derivium was engaging in fraud. On its face, contrary to plаintiffs’ assertions, the Release is not a general indemnity agreement, but rather a waiver of Derivium‘s right to bring suit against Morgan Keegan in the event that Morgan Keegan was unable to secure market-prevailing prices fоr Derivium‘s securities purchases. And in any event, as a general matter, entering into a release agreement with a fraudster is not at all indicative that one knew of the fraud, as one could not reasonably expect such an agreement to provide one shelter from that fraud‘s consequences.
Accordingly, we conclude that the district court correctly dismissed plaintiffs’ claims for failing to adequately allege thаt Morgan Keegan had actual knowledge of Derivium‘s fraud.
In addition, even if we were to disagree with the district court‘s holding as to the sufficiency of the Complaint‘s allegations regarding Morgan Keegan‘s knowledge of Derivium‘s fraud, we would still affirm the Complaint‘s dismissal for failure to allege that Morgan Keegan provided “substantial assistance” to Derivium‘s fraudulent scheme. Cf. Algarin v. Town of Wallkill, 421 F.3d 137, 139 (2d Cir.2005) (It is proper to uphold a dismissal for failure to state a claim basеd “on any ground supported by the record.“). “Substantial assistance exists where (1) a defendant affirmatively assists, helps conceal, or by virtue of failing act when required to do so enables the fraud to proceed, and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated.” UniCredito Italiano SpA v. JPMorgan Chase Bank, 288 F.Supp.2d 485, 502 (S.D.N.Y.2003) (internal quotation marks omitted). It is well-established that “[t]he mere fact that participants in a frаudulent scheme use accounts at [a financial institution] to perpetrate it, without more, does not in and of itself rise to the level of substantial assistance.” S.E.C. v. Lee, 720 F.Supp.2d 305, 330 (S.D.N.Y.2010) (internal quotation marks omitted); see also, e.g., DePinto v. Ashley Scott, Inc., 222 A.D.2d 288, 290, 635 N.Y.S.2d 215 (1st Dep‘t 1995); Musalli Factory for Gold & Jewellry v. JPMorgan Chase Bank, N.A., 261 F.R.D. 13, 25 (S.D.N.Y.2009), aff‘d. 382 Fed.Appx. 107 (2d Cir.2010) (summary order).
Here, the Complaint does not allege that Morgаn Keegan did anything in support of Derivium‘s fraud other than execute securities transactions on Derivium‘s behalf and at Derivium‘s direction. Under the law of this Circuit, this is insufficient to constitute “substantial assistance.” Accordingly, we conclude that, even assuming that the Complaint meets the heightened pleading requirements of
We have considered all of plaintiffs’ other arguments and find them to be without merit. Accordingly, for the foregoing reasons, the judgment of the district court is AFFIRMED.