United States District Court, E.D. New York
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For Jonathan Landow, Plaintiff: Bernard A. Nathan, LEAD ATTORNEY, Bernard A. Nathan, P.C., West Islip, NY.
For Wachovia Securities, LLC, Wells Fargo Advisors, LLC, George M. Gordon III, Walter R. Anderson, Defendants: David Alan Picon, LEAD ATTORNEY, Proskauer Rose LLP, N.Y., NY.
Sandra J. Feuerstein, United States District Judge.
On June 29, 2012, plaintiff Jonathan Landow (" plaintiff" ) commenced this action against defendants Wachovia Securities, LLC (" Wachovia" ), Wells Fargo Advisors, LLC (" Wells Fargo" ), Robert William Eddy (" Eddy" ), George M. Gordon III (" Gordon" ), Walter R. Anderson (" Anderson" ) and Walter Randolph
Anderson, Jr. (" Anderson Jr." ), asserting claims, inter alia, seeking damages for fraud, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and violations of certain rules of the National Association of Securities Dealers (" NASD" ) and New York Stock Exchange (" NYSE" ). Pending before the Court are: (1) defendants' motion to dismiss the complaint in its entirety pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a claim for relief; and (2) plaintiff's cross motion pursuant to Rule 15(a)(2) of the Federal Rules of Civil Procedure for leave to amend the complaint. For the reasons set forth below, defendants' motion is granted and plaintiff's cross motion is denied.
A. Factual Background
Plaintiff owned a corporation, New York Medical, Inc. (" N.Y. Medical" ), through which he sought to establish an employee stock ownership plan (ESOP) in order to " diversify his personal assets and simultaneously reward employees of N.Y. Medical." (Compl., ¶ ¶ 6, 81). Specifically, plaintiff, " decided to engage in a so-called seller-financed ESOP transaction with leveraged qualified replacement property (QRP), as defined in Section 1042 of the Internal Revenue Code." (Compl., ¶ 84).
On November 30, 2000, N.Y. Medical and plaintiff entered into a letter agreement with Citibank, N.A. (" Citibank" ), pursuant to which Citibank agreed to lend N.Y. Medical fifteen million dollars ($15,000,000.00) upon N.Y. Medical's execution of a demand note payable in that amount to Citibank. (Compl., ¶ 85). On that same date: (1) Citibank loaned N.Y. Medical fifteen million dollars ($15,000,000.00); (2) N.Y. Medical loaned the entire amount of the Citibank loan proceeds to its ESOP; (3) the ESOP used the entire amount of N.Y. Medical's loan proceeds to purchase four hundred fifty thousand (450,000) shares of N.Y. Medical's stock from plaintiff; (4) plaintiff used the proceeds from the stock sale to lend N.Y. Medical fifteen million dollars ($15,000,000.00); and (5) N.Y. Medical used the proceeds of plaintiff's loan to satisfy its obligation under the Citibank demand note. (Compl., ¶ 86). As a result of those transactions, plaintiff did not retain any cash from his sale of stock to the ESOP, but held a note of N.Y. Medical in the amount of fifteen million dollars ($15,000,000.00) evidencing his loan to that company. (Compl., ¶ 87).
After plaintiff's sale of stock to the ESOP, he " sought to purchase certain QRP in order to defer under Section 1042 of the Internal Revenue Code recognition of any gain that he had realized on the sale of that stock." (Compl., ¶ 88). Since plaintiff did not retain any cash from his sale of stock to the ESOP, " he was unable to buy that QRP without borrowing the funds to do so." (Id.) On November 1, 2000, plaintiff, N.Y. Medical and Citibank executed a " Revolving Credit Note (Multiple Advances)" (" the revolving credit note" ), pursuant to which Citibank made available to plaintiff a line of credit not exceeding twelve million dollars ($12,000,000.00). (Compl., ¶ 89). According to plaintiff, the line of credit was a recourse loan on which he was allowed to draw during the period from November 1, 2000 to October 31, 2001. (Id.) On that same
date, (1) plaintiff executed a " General Hypothecation Agreement" (" GHA" ), pursuant to which he pledged certain rights to the QRP he intended to purchase with the loan proceeds that he borrowed against the line of credit as security for the line of credit, (Compl., ¶ 90); and (2) N.Y. Medical executed a " General Security Agreement," pursuant to which it granted a security interest in all of its assets to Citibank as collateral for its obligations under the revolving credit note. (Compl., ¶ 91). Between November 2, 2000 and November 29, 2001, plaintiff purchased floating rate notes (" FRNs" ) as QRP at a total cost of fifteen million dollars ($15,000,000.00). (Id.)
On February 11, 2002, plaintiff and his wife executed the following documents amending the revolving credit note and GHA: (1) an " Amended and Restated Revolving Credit Note (Multiple Advances)" (" amended revolving credit note" ), inter alia, increasing the Citibank line of credit to $13.5 million (" the Citibank increased line of credit" ), and substituting plaintiff's wife for N.Y. Medical as a borrower thereunder; and (2) an " Amended and Restated General Hypothecation Agreement" (" the amended GHA" ). (Compl., ¶ 92). According to plaintiff, he drew upon the Citibank increased line of credit, and used $1.5 million of his own funds, to purchase " $15 million of FRNs," and pledged those FRNs as security for the Citibank transaction. (Compl., ¶ 93).
Plaintiff alleges that " [i]n proposing a line of credit * * *, Citibank informed him that the use of FRNs as QRP would achieve a result known as 'zero-cost borrowing', which was [his] objective." (Compl., ¶ 95). According to plaintiff, on June 12, 2002, after Citibank failed to provide such " zero-cost borrowing" during 2001 and 2002, he retained Corporate Solutions Group, LLC (" CSG" ) " to assist him in negotiating with a different lender a new loan of $13.5 million dollars [sic] that would replace the Citibank increased line of credit." (Compl., ¶ 95).
On or about August 2002, CSG informed plaintiff about Derivium Capital, LLC (" Derivium" ), (Compl., ¶ 96), a limited liability company of which Charles Cathcart (" C. Cathcart" ) was a fifty percent (50%) owner and Yuri Debevc and Scott Cathcart (" S. Cathcart" ) were each twenty-five percent (25%) owners (collectively, " the Derivium owners" ). (Compl., ¶ ¶ 2, 35). At all relevant times: (1) other entities, including Optech Ltd. (" Optech" ), Bancroft Ventures, Ltd. (" Bancroft" ), Witco Services Ltd. (" Witco" ) and Veridia Solutions LC (" Veridia" ) (collectively, " the Derivium alter ego companies" ), were wholly owned or controlled by the Derivium owners, (Compl., ¶ ¶ 3, 35); and (2) Anderson Jr. was an employee, the director of client services and an account executive of Derivium, (Compl., ¶ 9).
According to plaintiff, " Derivium perpetrated a fraudulent securities loan scheme known as the Derivium 90% Securities Loan Program" (" the 90% Loan Program" ), (Id.), pursuant to which Derivium " purported to make loans to borrowers worth 90% of the value of their securities." (Compl., ¶ 36). According to plaintiff, borrowers under the 90% Loan Program " would deposit their securities as collateral for the 90% Loan into accounts at one of several major brokerage houses, including Wachovia * * *, where their securities would purportedly be held and hedged by Derivium using what Derivium purported to be * * * a secret, proprietary hedging strategy. At the end of the loan term, borrowers could pay the loan balance and retrieve their collateral, surrender their collateral in satisfaction of the loan, or renew their loan." (Id.)
On August 19, 2002, Derivium prepared separate " ESOP QRP Loan-Indicative FRN Loan Term Sheets" (" the proposed loan term sheets" ) with respect to each of plaintiff's FRNs, proposing to lend plaintiff, on a nonrecourse basis, ninety percent (90%) of the face value of the respective FRN at a net interest rate calculated in accordance therein, (Compl., ¶ 97), and prohibiting (a) Derivium from calling the respective loan before maturity unless plaintiff was in default on that loan and (b) plaintiff from prepaying the principal of the respective loan before maturity, (Compl., ¶ 98).
On or about August 20, 2002, plaintiff received a letter from CSG outlining a proposal for ninety percent (90%) financing of the FRNs with no recourse loans. (Compl., ¶ 99). Shortly thereafter, plaintiff spoke to a CSG representative who represented, inter alia, (a) that the ninety percent (90%) financing was a loan and not subject to tax; (b) that the loan allows for a potential deferral of tax until the loan is due; and (c) that at the end of the loan term, the borrower would have the option to have the collateral, i.e., his FRNs, returned or the loan terminated. (Id.)
On or about August 28, 2002, Derivium sent plaintiff certain information regarding the proposed loans under the 90% Loan Program, including a " Master Agreement to Provide Financing and Custodial Services" and a separate Schedule A with respect to each of his FRNs, each containing information that was " materially identical" to the information contained in the proposed loan term sheets. (Compl., ¶ 100). On September 20, 2002, Derivium sent plaintiff additional documents, (Compl., ¶ 101), and from September 23 to 26, 2002, Derivium sent plaintiff revised versions of certain of the documents previously sent, none of which differed materially from the documents previously sent to plaintiff on August 28, 2002. (Compl., ¶ 102).
According to plaintiff, " [a] major feature in the marketing material for the [90% Loan Program] was that the transaction was a loan, not a sale, so even though [he] would borrow 90% of the value of his securities as a loan * * *, [he] was told the refinance would not affect his capital gains tax deferral recognition from his prior [Citibank] transaction and [he] could continue to defer paying capital gains tax for the duration of the loan terms." (Compl., ¶ 13, 52). Other features of the 90% Loan Program that were marketed, and " which further induced [plaintiff] to enter into [it]," were: (1) that, during the terms of the respective loans, (a) the loans were non-recourse loans, (b) plaintiff would retain beneficial ownership in the pledged securities, (c) plaintiff was only required to make payments of interest, and (d) plaintiff could pre-pay the loan and receive the return of his pledged securities; and (2) that at the end of the loans' respective terms, plaintiff could either " (a) not repay any loan principal or accrued interest and relinquish his beneficial ownership interest in the securities to the Lender or (b) pay the loan principal and all accrued interest in full and receive the return of his pledged securities." (Compl., ¶ ¶ 20, 52-54). According to plaintiff, " [t]he right to reacquire the pledged securities at the end of the loan term by paying back the principal and interest together with his retention of beneficial ownership throughout the term of the loans was extremely important to [him] and was an inducement for him to enter into the [90% Loan Program]." (Compl., ¶ 21).
Plaintiff alleges that the representations " crafted and disseminated" by the Derivium owners about the 90% Loan Program in their publications, and through the company's website and consultants, " were false
and gross lies," (Compl., ¶ 15), " intended to create the impression that they would employ derivative instruments to protect the value of the collateral and that the collateral would not be sold." (Compl., ¶ 37). Plaintiff further alleges that Wachovia knew of those representations, (Compl., ¶ ¶ 57-58, 61), and that they were false. (Compl., ¶ 52).
As of December 31, 2002, plaintiff was not required to recognize any of the gain that he realized on the sale of his N.Y. Medical stock to the ESOP, having met the requirements of Section 1042 of the Internal Revenue Code. (Compl., ¶ 94).
On or about April 9, 2003, plaintiff entered into six (6) loans with Derivium and Bancroft under the 90% Loan Program. (Compl.,¶ ¶ 13, 50, 103). The terms of those loans ranged from twenty-seven (27) to thirty-eight (38) years. (Compl., ¶ ¶ 13, 65-66). According to plaintiff, at the time he entered into the loan transactions with Derivium, he " was in his early forties, such that based on his expected life expectancy, there was a probability that at the time the loan was due [he] would be deceased and, as such, his estate would have received a stepped up basis and, therefore, there would be little or no tax [sic] capital gains tax to his estate." (Compl., ¶ 19).
Plaintiff alleges that the Master Loan Financing and Security Agreement (" MLA" ) for every loan into which he entered under the 90% Loan Program indicates that " Derivium has the authority to transfer, pledge, or sell the collateral, but only during the Loan Term." (Compl., ¶ 46). According to plaintiff, the MLAs were not effective until the respective Loan Schedule was signed, and each Loan Schedule indicated that the Loan Term did not begin until the loan funds were disbursed to him. (Id.)
On April 15, 2003, pursuant to plaintiff's instruction, Citibank transferred his FRNs portfolio to a brokerage account at Wachovia, which plaintiff had opened at Derivium's instruction. (Compl., ¶ ¶ 62, 104). Plaintiff alleges that he was introduced to Wachovia, and its registered representatives, by Derivium. (Compl., ¶ ¶ 12, 54).
According to plaintiff, when borrowers under the 90% Loan Program opened an account at Wachovia, they signed an Account Application that did not authorize Wachovia to sell any of the securities pledged. (Compl., ¶ 63). Plaintiff alleges that Wachovia selected Gordon as the financial advisor of his Wachovia brokerage account, but concealed from him the fact " that Gordon was also the financial advisor of all brokerage accounts held in the name of Derivium's entities and affiliates at Wachovia ." (Compl., ¶ ¶ 62-63). Plaintiff further alleges that he " had numerous discussions with Wachovia representatives," including Gordon, during which he emphasized: (1) " that the loan with Derivium was a refinance of his QRP loan to replace the securities he had sold to an ESOP[; ]" and (2) " his great concern that the refinance of his QRP loan would not create any tax incidence and destroy the deferral of capital gains tax for the original QRP loan transaction." (Compl., ¶ ¶ 18, 61).
On April 21, 2003, plaintiff executed certain documents authorizing Wachovia to transfer each of his FRNs from his Wachovia brokerage account to a certain account maintained by Bancroft at Wachovia. (Compl., ¶ ¶ 63, 105). According to plaintiff, the authorization to transfer his FRNs into Bancroft's Wachovia account did not authorize Wachovia to sell those securities, (Compl., ¶ 63), but Wachovia, nonetheless, sold them immediately upon their receipt without informing him, then transferred ninety percent (90%) of the proceeds from the sale to fund his loans and " pocketed" the remaining ten percent (10%). (Id.) According to plaintiff, " Wachovia was aware that each sale of [his] securities was in violation of the loan terms because the sales took place before the loan term began." (Compl., ¶ 70).
After plaintiff received the proceeds of the loans into which he entered under the 90% Loan Program, he used a portion of those proceeds to repay the outstanding balance on the Citibank increased line of credit. (Compl., ¶ 106).
Plaintiff alleges that he continued to receive from Wachovia quarterly account statements " falsely represent[ing] that the securities pledged as collateral were still held as collateral" until August 2005, when he was advised that Optech had taken over his collateral from Bancroft. (Compl., ¶ 65). According to plaintiff, by generating such false quarterly statements, thereby concealing the fact that his securities had immediately been sold upon their transfer to plaintiff's account at Wachovia, " Wachovia and Gordon intentionally aided Derivium to continue to conceal the fraudulent nature" of all six (6) of the loans into which he entered under the 90% Loan Program. (Compl., ¶ 65).
The 90% Loan Program, to which plaintiff refers as a " Ponzi scheme," collapsed and Derivium filed for bankruptcy in 2005. (Compl., ¶ 40).
Plaintiff alleges that the sale of his FRNs through the 90% Loan Program caused him " to lose the right to defer capital gains tax liability." (Compl., ¶ 56). According to plaintiff, on or about July 2007, he received notice from the United States Internal Revenue Service (" IRS" ) that the loans into which he entered under the 90% Loan Program constituted a sale of his QRP and, therefore, there was no deferral of taxes from his stock sale to the ESOP and his failure to report the gain on the stock sale in the 2003 calendar year resulted in income taxes past due, as well as penalties and interest. (Compl., ¶ 107). According to plaintiff, his tax indebtedness to the IRS exceeds four million dollars ($4,000,000.00). (Compl., ¶ 117). Plaintiff alleges that although he received notice of taxes, interest and penalties due from the IRS in 2007, " the notice made no mention of the conduct of Wachovia in the fraudulent scheme." (Compl., ¶ 66). Plaintiff was also notified by the State of New York (" the State" ) that he owed income taxes, penalties and interest in an amount in
excess of one million dollars ($1,000,000.00) as a result of the sale of his QRP property, although he does not indicate when he received such notice. (Compl., ¶ ¶ 116-117).
Plaintiff alleges that notwithstanding the tax notices, he " remained unaware" that his securities had been sold and that Wachovia " knowingly and intentionally aided Derivium and played a major role in" the 90% Loan Program until July 2010, (Compl., ¶ ¶ 50, 62, 66, 71), " when counsel retained by [him] to represent him against the I.R.S.'s claim for deficient taxes advised [him] that Wachovia had played an active role in the Derivium fraudulent scheme." (Compl., ¶ 67).
According to plaintiff, certain " red flags" should have alerted Wachovia that Derivium and Bancroft were " unscrupulous clients," triggering a duty by Wachovia to investigate the 90% Loan Program transactions, including: (1) that " Derivium, with only modest assets of its own, generated * * * $1 billion in securities trades," (Compl., ¶ 28); (2) that " [s]ecurities with enormous value were transferred from other accounts to Derivium and Bancroft accounts maintained by Wachovia and sold by Wachovia immediately on instructions from Derivium, (id.); and (3) that Debevc, who was not an officer or employee of Bancroft, had signature authority for both Derivium and Bancroft accounts and " moved as much as $5 million or more at a time between th[o]se accounts, at will." (Compl., ¶ ¶ 29, 74). In addition, plaintiff alleges that " Derivium and its owners had a close relationship with Wachovia," insofar as Anderson Jr., " who raked off hundreds of thousands of dollars of commissions from the borrowers' securities sales [under the 90% Loan Program] * * * directed brokerage work for the sale of the securities loan collateral to Wachovia, where his father served as Vice President." (Compl., ¶ 30).
Plaintiff alleges, inter alia : (1) that " Wachovia knew that Derivium was depicting th[e] [securities sales under the 90% Loan Program] as 'securities loans' in which the borrowers were retaining ownership, even though (unbeknownst to the borrowers) Derivium was selling 100% of the collateral immediately" because Wachovia, particularly Gordon, was doing the selling " and assisting in the laundering of the proceeds," (Compl., ¶ ¶ 33, 44, 47-48, 59); (2) that Wachovia " knew, or should have known (in the exercise of due diligence and in compliance with NYSE Rule 405 'know your customer' requirements and NYSE Rule 342 'approval, supervision, and control' requirements) that uses made of investor's securities in the [90% Loan] [P]rogram did not constitute 'hedging' as that term is used in the financial industry," (Compl., ¶ 47); and (3) that Wachovia " intentionally and substantially aided" Derivium in the 90% Loan Program by: (a) lending ...