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COR Clearing, LLC v. Calissio Resources Group, Inc.

United States District Court, D. Nebraska

November 6, 2017

COR CLEARING, LLC, a Delaware limited liability company; Plaintiff,
v.
CALISSIO RESOURCES GROUP, INC., a Nevada corporation; ADAM CARTER, an individual; SIGNATURE STOCK TRANSFER, INC., a Texas corporation; DOES 1-50, TD AMERITRADE CLEARING, INC., a Nebraska corporation; NATIONAL FINANCIAL SERVICES LLC, a Delaware limited liability company; SCOTTRADE, INC., an Arizona corporation; and E-TRADE CLEARING, LLC, a Delaware limited liability company; Defendants.

          MEMORANDUM AND ORDER

          Joseph F. Bataillon Senior United States District Judge

         This matter is before the court on a motion for summary judgment filed by defendant Signature Stock Transfer, Inc. (“SST”), Filing No. 237; a joint motion for summary judgment filed by defendants National Financial Services, LLC, TD Ameritrade Clearing, Inc. (“TDAC”), E-Trade Clearing, LLC, and Scottrade, Inc. (collectively, the “broker defendants”), Filing No. 255; and a motion for partial summary judgment filed by plaintiff COR Clearing, LLC (“COR”), Filing No. 258. The court heard oral argument on the motions on October 17, 2017, and October 23, 2017.

         This is an action for declaratory relief, unjust enrichment, fraud, and conversion in connection with a securities transaction. Jurisdiction is based on diversity of citizenship under 28 U.S.C. § 1332.

         Essentially, COR alleges that defendants Calissio Resources Group, Inc. (“Calissio”), Adam Carter[1], and SST perpetrated a fraud on COR, the securities clearing system, and the marketplace by exploiting a weakness in clearing procedures in connection with Calissio stock. It seeks to recover funds debited from its account as a result of the allegedly fraudulent dividend scheme. COR asserts claims for fraud under Nebraska law against Calissio, Carter, and SST, and asserts claims for unjust enrichment and conversion against the broker defendants. Default judgment has been entered against Calissio. See Filing No. 109.

         COR moves for summary judgment on its claim for conversion against the broker defendants. The broker defendants, in turn, move for a summary judgment of dismissal on all of COR's claims against them. SST moves for a summary judgment of dismissal on COR's fraud claim.

         I. BACKGROUND AND OVERVIEW

         The remaining claims in this dispute involve several financial services industry organizations that operate within the financial markets and the indirect holding system. An overall understanding of that generally-automated system, the rules that govern it, and the parties' respective roles in the system is necessary at the outset. Securities transactions are governed by both state and federal law.

         Plaintiff COR is an independent clearing and settlement firm. Clearing firms generally handle the back-office details of securities transactions between broker-dealers. A broker-dealer is an individual or firm that trades securities. A clearing or carrying firm also maintains custody of securities and assets such as cash. An introducing firm accepts orders to trade but has an arrangement with a clearing or carrying firm to maintain custody of the securities account. Generally, introducing broker-dealers interact with the end client, while a clearing broker is responsible for the confirmation, receipt, settlement, delivery and record-keeping tasks involved in processing securities transactions.

         The broker defendants are all financial institutions that provide clearing services to their affiliated introducing broker-dealers (e.g., defendant TDAC provides custody and clearing services for clients of TD Ameritrade). COR's principal business is the provision of custody and settlement services to introducing broker-dealers. It provides such services to introducing broker J.H. Darbie & Co. (“J.H. Darbie”). J.H. Darbie has a clearing contract with COR.

         Brokers and securities transactions are generally regulated under the Securities Exchange Act of 1934 by the Financial Industry Regulatory Authority (“FINRA”). See 15 U.S.C. § 78q-1(a)(1). FINRA is a non-governmental self-regulatory organization that regulates member broker defendants and exchange markets. Every firm and broker that sells securities to the public in the United States must be licensed and registered by FINRA. See Release, Sec. & Exch. Comm'n, S.E.C. Release No. 34-50700, Concept Release Concerning Self-Regulation (Nov. 18, 2004), available at http://www.sec.gov/rules/concept/34-50700.htm.

         The Depository Trust and Clearing Corporation (“DTCC”) is the Securities and Exchange Commission (“SEC”) approved central clearing firm for the vast majority of shares traded in United States markets. It functions as a clearing house to process and record trades, settle trades, issue reports to the broker-dealers, and electronically transfer funds and shares. Plaintiff COR Clearing and the defendant brokers are participant members of the DTCC. As participants, they have agreed to abide by DTCC procedures.

         The indirect holding system is a system in which securities are not physical securities represented by certificates, but are represented as “book entries” in a securities account. See Chase Inv. Servs. Corp. v. Law Offices of Jon Divens & Assocs., LLC, 748 F.Supp.2d 1145, 1167 (C.D. Cal. 2010), aff'd, 491 Fed.Appx. 793 (9th Cir. 2012); 6 Thomas Lee Hazen, Treatise on the Law of Securities Regulation § 23:1. The indirect holding system is governed by Article 8 of the Uniform Commercial Code (“U.C.C.”), which, in turn, relies on definitions in federal securities laws. See, e.g., Neb. Rev. Stat. § 8-101 et seq.[2] Article 8 of the U.C.C. was revised in 1994 and has been adopted in Nebraska. Neb. Rev. Stat. § 8-101 et seq.

         Defendant Calissio is the issuer of the stock (CRGP) shares at issue. Defendant SST is Calissio's transfer agent. Transfer agents record changes of ownership, maintain the issuer's security holder records, cancel and issue certificates, distribute and tabulate proxies, and distribute dividends. See Sec.& Exch. Comm'n, S.E.C. Release No. 34-76743, Comments on Concept Release: Transfer Agent Regulations, 2016 WL 2652241 at *2 (April 13, 2016); see also 12 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 5485 (perm. ed., rev. vol. 2004). Most transfer agents, including SST, deposit shares into the DTCC via the Deposit/Withdrawal at Custodian (“DWAC”) system, which is a computerized system for automatic transfers of cash and securities that permits DTCC participants to request the movement of shares to or from the issuer's transfer agent electronically.

         Transfer agents are required to register with the SEC or a bank regulatory agency under Section 17A of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78q-1(c). See also 17 C.F.R. § 240.17A. They are not part of FINRA, nor are they participants of the DTCC, but are registered with the DTCC as long as the issuer the transfer agent represents is a participant with the DTCC. There is no self-regulatory agency that governs transfer agents the way FINRA governs brokers and broker defendants.

         Transfer agents are also subject to provisions of the U.C.C. of the state in which the issuer is incorporated.[3] Comments on Concept Release, 2016 WL 2652241, at *2. Article 8 Part 3 of the U.C.C. covers transfer of certificated and uncertificated securities and the rights and obligations of transfer agents. See generally U.C.C. § 8-301 et seq. (Am. Law. & Inst. & Unif. Law Comm'n 1994); e.g., Neb. Rev. Stat. § 8-301 et seq.

         In addition to J.H. Darbie and the DTCC, several other entities are tangentially connected to the transactions at issue herein but are not parties. Those are Alpine Securities Corporation (“Alpine”), another financial services firm that suffered losses in connection with Calissio stock, and Nobilis Consulting, LLC (“Nobilis”) and Beaufort Capital Partners, LLC (“Beaufort”), who are investors who held promissory notes on Calissio's debt and later converted that debt to shares of Calissio stock. J.H. Darbie is Nobilis's and Beaufort's introducing broker, who uses COR for clearing and settlement.

         FINRA is authorized by the S.E.C. to adopt and administer the Uniform Practice Code (“UPC”), “the rules and regulations governing [over-the-counter] secondary market securities transactions.” In re THCR/LP Corp., No. 04-46898/JHW, 2006 WL 530148 at *4 (Bankr. D. N.J. Feb. 17, 2006). FINRA rules regulate payment of dividends. In re Arctic Glacier Int'l, Inc., No. 12-10605(KG), 2016 WL 3920855, at *5 (Bankr. D. Del. July 13, 2016), aff'd, 255 F.Supp.3d 534 (D. Del. 2017). Under UPC 11140, FINRA determines which shareholders are entitled to a distribution by setting two dates: the “record date” and the “ex-dividend date” or “ex-date.” Id. at *6; see In re THCR/LP Corp., No. 04-46898/JHW, 2006 WL 530148 at *5; National Association of Securities Dealers (“NASD”) (now FINRA) Notice to Members 00-54 (August 2000). The record date is fixed by the issuer and determines the holders of equity securities who are entitled to receive dividends or other distributions. See Arctic Glacier, 2016 WL 3920855, at *6 (emphasis omitted). The “ex-date” is “‘the date on and after which the security is traded without a specific dividend or distribution.'” Id. (quoting UPC Rule 11120(c); see In re THCR/LP Corp., 2006 WL 530148 at *5. “‘Taken together, these two dates delimit the timeframe during which a security, when sold, carries with it from the seller to the buyer the right to receive a distribution'” which is known in the industry as a “due bill.” Arctic Glacier, 2016 WL 3920855, at *6 (quoting In re THCR/LP Corp., 2006 WL 530148 at *5); see UPC Rule 11140.

         Ordinarily, the ex-date precedes the record date, but a dividend or distribution that is twenty-percent or more of the value of the subject security qualifies as a “special dividend, ” and the ex-date is set by FINRA as the first business day following the payable date. See NASD Notice to Members 00-54 (August 2000). If the record date precedes the ex-date, and the security is sold during the period between the two, the stock “carries with it the right to receive a distribution, a ‘due bill, ' from the seller to the buyer.” Karathansis v. THCR/LP Corp., No. CIV. 06-1591(RMB), 2007 WL 1234975, at *4 (D.N.J. Apr. 25, 2007), aff'd sub nom. In re THCR/LP Corp., 298 Fed.Appx. 120 (3d Cir. 2008); see FINRA Uniform Practice Advisory (UPC # 55-13) (December 19, 2013); NASD Notice to Members 00-54 (August 2000) (noting that a due bill is a promissory note for the dividends that is attached to a stock that is traded between the record date and the ex- date); Silco, Inc. v. United States, 779 F.2d 282, 284 (5th Cir. 1986).

         The DTCC implements the allocations of due bills under UPC 11140. The DTCC's interim accounting process automates the settlement of due bills. The process entails capturing on a daily basis all the trade settlements that include due bills and then debiting and crediting the accounts of member firms in order to pass the dividend proceeds to the appropriate party.

         Each security is assigned a Committee on Uniform Securities Identification Procedures (“CUSIP”) number. A CUSIP number is a unique nine-character alpha/numeric code to a security by Standard and Poor's Corporation. The number is used to expedite clearance and settlement. A CUSIP number is assigned to each issue and may need to be changed when there is a Corporate Action.

         II. FACTS

         The facts are not in serious dispute. The following facts are gleaned from the parties' respective statements of uncontroverted facts and from the exhibits submitted in connection with the motions. See Filing No. 238, SST Brief at 3-7; Filing No. 249, COR's Brief at 4-15 Filing No. 277, SST Reply Brief at 2-5; Filing No. 256, Brokers' Brief at 5-14; Filing No. 289, COR's Brief at 4-23; Filing No. 296, Brokers' Reply brief at 4-14; Filing No. 259, COR's Brief at 3-13; Filing No. 284, Brokers' Brief at 5-13; Filing No. 299, COR's Reply Brief at 39-53; Filing Nos. 239, 250, 260, 261, 278, 285, 290, Indices of Evid. The record shows that Calissio is an issuer of penny stock in a corporation engaged in mining activities in Mexico.[4] Calissio had a contractual relationship with SST as its transfer agent. SST became Calissio's transfer agent in roughly 2001. Filing No. 250-2, Index of Evid., Ex. A, Deposition of Jason Bogutski at 6.

         On June 1, 2015, Calissio announced a “stock repurchase program of up to 1.5 million of the Company's outstanding common shares.” Filing No. 290-20, Index of Evid., Ex. R, Calissio Annual Information Disclosure at 13. On June 16, 2015, Calissio issued a press release, announcing the company's

first quarterly cash dividend of approximately USD$1.3 million, or USD$0.011 per common share of the Company (each a "Common Share"), payable on or about August 17, 2015 to the holders of the issued and outstanding Common Shares as of the close of business on June 30, 2015. The Board also approved a special stock dividend of 3% payable August 17, 2015 to shareholders of record at the close of business on June 30, 2015.

Filing No. 260-12, Index of Evid., Ex. K.[5] The Calissio Board of Directors' Statement of Consent states that “the Company hereby authorizes a $0.011 per common regular share (free trading share) cash dividend to its shareholders. The dividend shall have a record date of June 30, 2015, an ex-dividend date of June 26, 2015 and a payment date of August 17, 2015.” Filing No. 250-9, Index of Evid., Ex. H. People who owned CRGP shares on the record date were to be paid the dividend. Calissio's Annual Information Disclosure also states that [a]s of June 30, 2015, Calissio had 129, 460, 000 issued and outstanding shares of common stock with a par value of $.01 per share. Filing No. 290-20, Index of Evid., Ex. R. The Annual Information Disclosure also shows that “[e]ffective on October 6, 2014 the Company changed its name to Calissio Resources Group, Inc. having new CUSIP number of 130 88P 102.” Id. at 2. The Annual Information Disclosure listed the following restriction on the transfer of securities: “As of June 30, 2015, other than 27, 179, 423 shares of its common stock that are free-trading, all the other 102, 280, 577 shares are restricted and subject to Rule 144.[6] The combined total of free trading and restricted shares issued and outstanding on June 30, 2015 are 129, 460, 000.” Id. at 4. On August 18, 2015, FINRA issued an ex-date determination of August 19, 2015, with respect to the Calissio dividend. Filing No. 261-2, Index. of Evid., Ex. A, Answers to Requests for Admission at 14.

         The record shows that investors Nobilis and Beaufort had earlier loaned money to Calissio and held promissory notes for the debts. Between July 29, 2015, and August 19, 2015, Nobilis and Beaufort converted that debt to equity. Filing No. 261-2, Index of Evid., Ex. A, Answers to Requests for Admission at 14-15. Calissio issued new shares as a result of the debt-to-equity conversion through its transfer agent, SST, who admits that it records the issuance of shares by its customer companies, maintains records of an issuer's stock and bond holders, records changes of ownership, issues or cancels certificates, and resolves problems arising from lost, destroyed, or stolen certificates. See Filing No. 278-1, Ex. 32, FINRA FAQs.

         As a result of converting the debt to equity, Nobilis obtained 327 million CRGP shares, and Beaufort obtained 90 million CRGP shares. Filing No. 261-2, Answers to Requests for Admission at 14-15. Nobilis and Beaufort were customers of J.H. Darbie, who was an introducing or correspondent broker who used COR as its clearing and settlement firm. COR Clearing admits that it approved the new shares for deposit on its platform. COR's client acknowledgement form, which is included in each tranche of each conversion of debt to equity, COR states that sales of the securities “may not be permitted by [COR] until such time that [COR] is satisfied that they are eligible for sale and transfer, without fear of impairment or violation of law or industry rule.” Filing No. 239, Index of Evid., Exs. 1B-12B. COR acknowledges it has a duty to prevent fraud generally, as well as to conduct anti-money-laundering reviews. Filing No. 278-6, Index of Evid., Deposition of Carlos Salas at 37; see also Filing No. 83, Transcript of Hearing dated Nov. 10, 2015 at 42-45 (Salas testimony acknowledging duties to conduct a heightened review under FINRA Notice to Members 09-05).

         As part of its review under FINRA Notice 09-05, COR reviewed certain documentation relating to a conversion of shares. Filing No. 239, Exs. 1-12. COR provides its correspondent brokers with a Heightened Risk Securities Correspondent Guidebook and Heightened Risk Securities Deposit Document Requirements Checklist. Filing No. 278-3. After that review, COR deposited with the DTCC at least 340 million new shares of CBPB, thus permitting the shares to be traded. COR cleared shares that were sold by J.H. Darbie on behalf of Darbies's customers, Nobilis and Beaufort.

         Evidence shows that the supporting paperwork submitted to COR by its correspondent broker Darbie was factually inaccurate. See Filing No. 239, Exs. 1-12. The supporting documents show that Darbie's customers listed number of shares for each tranche of each conversion was under 10% of total shares but the aggregate was in excess of 10%. Id. Responses to COR's heightened risk security questionnaire show a possible Rule 144 violation and indicia that Calissio was a shell corporation given its lack of assets and business activity. Id.

         With respect to the Calissio shares issued in July and August 2015, SST prepared a form stock certificate in accordance with its written internal procedures once it received an issuance resolution and attorney opinion. Filing No. 278-4, Ex. 35, Affidavit of Jason Bogutski; Filing No. 278-5, Procedures. It reviewed the issuance resolution and the respective attorney opinions and found all shares issued during that time frame were free trading shares, consistent with other similar shares. Filing No. 278-4, Ex. 35, Affidavit of Jason Bogutski. SST reviewed a DWAC placed by the clearing firm COR, noted the number of shares that matched the number for each issue per the issuance resolution and opinion letter received and DWAC forms completed by the shareholder. The number of shares matched the number of shares shown on DTCC system placed by COR and SST completed the DWAC and SST was able to complete the DWAC. Id.

         The evidence establishes that Calissio instructed its transfer agent, SST, to issue the new shares with the same CUSIP number that was used for pre-record date shares. The parties agree that shares of stock that are issued after the announced record date for a dividend do not qualify for the dividend. The evidence also shows that the issuer generally ...


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