Rochlis v. United States ( 2020 )

In the United States Court of Federal Claims
Nos. 16-200T; 16-201T; 16-210T
Filed: January 14, 2020
* * * * * * * * * * * * * * * *
JON A. ROCHLIS, ANNE R. LAVIN, *
JON ROCHLIS AS EXECUTOR OR * Trial; Tax; Federal Tax
THE ESTATE OF IRENE M. ROCHLIS * Deductions; Theft Loss; 165
(AKA WARREN), * U.S.C. § 165; Treas. Reg. 1.165;
KENNETH ISHII, and SHERYL A. * State law; Constructive Sale.
ISHII, *
*
Plaintiffs, *
v. *
*
UNITED STATES, *
*
Defendant. *
*
* * * * * * * * * * * * * * *
Brian G. Isaacson, Isaacson Law Firm, Seattle, WA for plaintiffs.
Benjamin C. King, Jr., Trial Attorney, Department of Justice, Tax Division, Court
of Federal Claims Section, Washington, D.C., for the defendant. With him were Mary M.
Abate, Assistant Chief, Court of Federal Claims Section, David I. Pincus, Chief, Court
of Federal Claims Section, and Richard E. Zuckerman, Principal Deputy Assistant
Attorney General, Tax Division, United States Department of Justice.
OPINION
HORN, J.
The plaintiffs, Jon A. Rochlis, Anne R. LaVin, Jon Rochlis as Executor of the Estate
of Irene M. Rochlis (aka Warren), Kenneth Ishii, and Sheryl A. Ishii, filed complaints in the
United States Court of Federal Claims, seeking a tax refund from an alleged theft loss in
2009 as a result of the purported investments by Derivium Capital, LLC (Derivium). After
all plaintiffs filed claims for refund with the Internal Revenue Service (IRS) in 2013 for the
tax year 2009, all plaintiffs subsequently filed complaints in each of the above captioned
cases. The complaints and amended complaints in Case Nos. 16-200T, 16-201T, and
16-210T are substantially similar except for the amounts plaintiffs allege they lost due to
the theft at issue and the amount they seek to recover. 1 A three day trial was held and
1The court refers to Jon A. Rochlis, Anne R. LaVin, Jon Rochlis as Executor of the Estate
of Irene M. Rochlis (aka Warren), Kenneth Ishii and Sheryl A. Ishii together as the
plaintiffs. All the plaintiffs were represented by the same counsel of record, Mr. Isaacson,
and the cases all were tried simultaneously. When addressing an individual plaintiff, this
post-trial briefings on the legal and factual issues raised in these cases were filed by all
parties. After review of the transcripts, the testimony, the exhibits entered into the record
and the submissions subsequently filed by the parties, the court makes the following
findings of fact.
FINDINGS OF FACT
Derivium Capital
The parties stipulate2 that Charles Cathcart, “a Ph.D. economist, developed the
concept for a 90% stock loan program in 1997, and in the same year began promoting a
variety of 90% Loan products through FSC First Security Capital (Texas), which he co-
owned with several individuals, including Kenneth Calvert, David Kekich, Rob Rawlings,
and Clifford Lloyd.” (internal references omitted). The joint stipulations provide that “[i]n
1998, [Charles] Cathcart relocated the 90% Loan Program to Charleston, South Carolina
in order to exercise more control over it. In Charleston, [Charles] Cathcart formed First
Security Capital, LLC (‘FSC’), and thereafter FSC Texas ceased operations.” According
to the joint stipulations, Charles Cathcart held a 50% ownership interest in FSC and he
served as President. The joint stipulations indicate that “[e]ffective January 1, 2000, FSC’s
name was changed to Derivium Capital, LLC,” and “Derivium eventually bought out Lloyd,
Calvert, Rawlings and Kekich’s interests. By 1998, ownership of FSC was allocated as
follows: [Charles] Cathcart 50%, [Yurij] Debevc 25% and Scott [Cathcart] 25%.”3
Opinion identifies the plaintiff by individual name. The court notes, however, that Irene M.
Warren is identified in a number of different ways in the filings and the documents in Case
No. 16-201T. The complaint and amended complaint in Case No. 16-201T identified the
plaintiff as “Irene M. Rochlis (aka Warren),” and the second amended complaint identified
the plaintiff as “Jon Rochlis as Executor of the Estate of Irene M. Rochlis (aka Warren).”
Other filings in Case No. 16-201T identify the plaintiff as as the “Estate of Irene M.
Rochlis,” still others as “Irene Rochlis.” The court notes that the Master Loan Agreement,
discussed below, was signed by “Irene M. Warren,” therefore, when referring to actions
taken by the plaintiff in Case No. 16-201T regarding the Derivium transaction, the court
refers to the plaintiff as “Irene M. Warren.”
2 The joint stipulations in the above captioned cases come not only from agreement by
the named parties for these cases, but also are stipulations to facts that were previously
stipulated to by Charles Cathcart and the United States Department of Justice in United
States of America v. Charles Cathcart, et al., N.D. Cal., Case No: C-07-4762 (filed Nov.
19, 2009), and which the parties also agreed to stipulate in these cases. The preamble to
the joint stipulations in the above captioned cases states: “The parties to the above-
entitled action, having met and conferred, and upon determining that good cause exists,
hereby stipulate to those facts that were stipulated by Charles Cathcart and the
Department of Justice in United States of America v. Charles Cathcart, et al [sic], N.D.
Cal., Case No: C-07-4762 PJH, document 398, filed 11/19/09.” (emphasis in original).
3Debevc refers to Yurij Debevc, Charles Cathcart’s former business associate who
Charles Cathcart brought “into the business to oversee operations,” and Scott refers to
2
“Throughout its operation, virtually all of Derivium’s business consisted of the marketing
and administration of the 90% Loan Program.”
The joint stipulations make clear that
[t]he 90% Loan Program was marketed as a way for customers to: (a) obtain
the benefit of cash in an amount equal to 90% of the value of their securities;
(b) defer paying capital gains on the transaction; and (c) be protected
against the risk that the securities would depreciate while at the same time
preserving their ability to take advantage of any possible appreciation in the
securities’ value.
The parties also stipulate that
Derivium’s marketing materials emphasized the customer’s ability to
recover their securities at the end of the transaction term, stating that the
customer would “retain beneficial ownership” of his securities, such that “if
your equities increase in value, you keep all the upside,” and “[b]ecause you
still own your stocks, you retain all the potential for further gains.” These
statements were false, since Derivium sold its customers’ securities prior to
the inception of the transaction.
(alternation in original). The joint stipulations indicate that “[u]pon Derivium’s receipt of
the securities, in every case, the securities were immediately sold.” The parties also
stipulate that:
The marketing materials state that Cathcart[4] is a “world-recognized expert
in building and preserving wealth for clients through the application of
sophisticated hedging strategies,” whose “proprietary structures and
models are the foundation of the products offered through Derivium
Capital.” Derivium’s marketing materials also state that Derivium will
engage in “hedging” transactions to protect the value of customers’
securities. These statements were also false. Derivium never engaged in
hedging transactions. Rather, it simply sold its customers securities,
remitted an amount equal to 90% of the proceeds back to its customers,
and kept the remaining 10% for its own purposes, including paying
operating expenses and fees to its owners.
The joint stipulations of fact point to an obvious untruth. According to the parties’ joint
stipulation of facts:
Charles Cathcart’s son, Scott Cathcart, who, according to the joint stipulations,
“spearhead[ed] the marketing of the 90% Loan Program.”
4 The court notes that the joint stipulations, the parties’ submissions, and the trial
transcript refer to Charles Cathcart generically as “Cathcart.”
3
Following the sale of a customer’s securities, however, Derivium and the
supposed lenders faced a countervailing risk, which was that stock values
would rise. Because customers’ securities were immediately sold in every
case, if a customer elected under the MLA[5] to recover his securities at the
end of the transaction term, Derivium had to repurchase the securities on
the open market to return those shares to the customer.
The parties’ joint stipulation of facts also indicate that “[i]n the event that prices for
more than a few of the securities submitted as collateral increased substantially during
the transaction term, Derivium faced an inherent risk of being unable to satisfy the
obligations to customers. Despite this known risk, Derivium never engaged in hedging
transactions.”
In total, “[t]he 90% Loan Program generated approximately 3100 transactions,
totaling more than $1 billion in sale proceeds, 90% of which was used to fund the
purported loans to customers, leaving at least $100 million as the difference between the
purported loan proceeds and the value of the securities (the ‘Net Proceeds’).” The joint
stipulations continue: “Derivium used the Net Proceeds for a variety of purposes. First,
Derivium (and later Derivium Capital USA and Veridia) kept approximately 20 to 25% of
the Net Proceeds for itself in the form of commissions. Throughout its operation,
Derivium’s only significant source of income was commissions from the sale of customer’s
securities.” The stipulations provide that “[t]he bulk of the Net Proceeds (approximately
$45 million) was used to fund various start-up companies owned indirectly by [Charles]
Cathcart, [Yurij] Debevc and Scott [Cathcart] and located in Orangeburg and
Summerville, South Carolina (the ‘Start-Up Companies’).” According to the joint
stipulations: “The purported ‘hedging’ model implemented by Cathcart involved the
immediate sale of the customer’s securities and investment of the Net Proceeds into
Start-Up companies owned and controlled by the Principals,” and “[i]n fact, the provision
of funds to the Start-Up Companies did not constitute a genuine hedge, but rather was
nothing more than a speculative gamble.” “To adequately and truly hedge Derivium’s risks
related to the 90% Loan Program, Derivium would have had to purchase call options
correlated with its customers’ securities. In fact, the Net Proceeds from the 90% Loan
Program would have been insufficient to purchase adequate call options,” and moreover,
“Derivium did not maintain reserves of capital that could be drawn upon if the supposed
‘hedges’ failed.”
As early as 2001, Derivium began defaulting on its obligations to its clients when
the first transactions engaged in by Derivium in 1998 began maturing. According to the
parties’ joint stipulations, “Derivium defaulted because Derivium had no genuine hedges
in place, had no reserves, and the proceeds from new 90% Loan transactions were
5 Although not defined in the parties’ joint stipulation of facts developed for the above
captioned cases, the first joint stipulation of facts incorporating the facts that were
stipulated by Charles Cathcart and the United States Department of Justice in United
States of America v. Charles Cathcart, et al., define MLA as a “Master Agreement to
Provide Financing and Custodial Services.” See United States of Am. v. Cathcart et. al,
No. C 07–4762 PJH.
4
insufficient to allow Derivium to purchase the replacement securities on the open market
for those customers who did seek a return of their highly appreciated stocks.” “At the end
of 2002, Cathcart ceased marketing and administering securities transactions through
Derivium due to litigation by customers whose securities Derivium had failed to return at
maturity and due to an investigation by the California Department of Corporations.”
“Derivium’s operations were then assumed and divided among two new entities. Derivium
USA, which is wholly-owned by Cathcart, assumed all marketing and sales functions for
the 90% Loan Program. Veridia Solutions, LLC which is wholly-owned by Debevc,
performed the related administrative functions.”6
The joint stipulations indicate that “[o]ver the next few years, Derivium racked up
tens of millions of dollars in judgments from defaults – yet Cathcart and his co-promoters
continued to market and administer the 90% Loan Program.”7 Also according to the joint
stipulations, “[b]y 2008, Derivium’s failure to perform on its obligations resulted in claims
against Derivium totaling approximately $150 million.”
The parties in the above captioned cases stipulate that “the claim that the 90%
Loan Program involved ‘hedging’ is false or fraudulent. No funds were used to hedge any
90% Loan transactions. Cathcart’s claim that the use of the 90% Loan proceeds . . .
constituted hedges against securities was pure fiction and constituted nothing more than
an economic gamble.” The joint stipulations continue:
The claim that 90% Loan transactions are non-taxable loans is a false
statement. Derivium and/or the purported lender immediately sold the
customers’ securities at the inception of the transaction – and thus
representations that the securities would be “held” as “collateral” were false
or fraudulent. Because no genuine “lending” occurred, Cathcart’s and
Derivium’s claims that a foreign “lender” existed were false or fraudulent.
(internal references omitted).
As the United States Tax Court in Raifman v. Commissioner noted, the Derivium
program was tailored toward individuals
who held concentrated positions in a single marketable stock and wished to
generate liquidity without triggering a taxable event. The Derivium program
facilitated this monetization of stock by “lending” program participants up to
6 The joint stipulations note that, for the purposes of the joint stipulations in the above
captioned cases, “Derivium, Derivium USA, and Veridia are collectively referred to as
‘Derivium’ unless otherwise noted.” This Opinion likewise generically refers to Derivium.
7 The joint stipulations provide that “[b]y 2003, the remaining available funds from new
90% Loan transactions were used to pay commissions to Derivium and its successor
entities and to keep the lights on in the Charleston office,” and that “[o]ver time the
liabilities of the 90% Loan Program increased dramatically.”
5
90% of their stock’s fair market value. In return participants would surrender
to Derivium the ostensibly leveraged stock as “collateral” and would accrue
interest on the loan principal over the life of the loan. Participants were
prohibited from making any payments before loan maturity and, similarly,
Derivium was prohibited from calling the loan before maturity. Most
importantly, the loans were nonrecourse to the participant. Because a
Derivium loan was nonrecourse, a participant had no personal liability for
principal or interest and could instead choose--for example, should the
value of the participant’s stock drop over the agreement’s term--to default
and cede the collateral to Derivium. Alternatively, upon maturity of the loan,
participants could pay their balance due and request return of their
collateral, or renew and refinance the loan for an additional term in order to
monetize any appreciation of the collateral that occurred during the initial
loan term.
Raifman v. Comm’r, T.C.M. 2018-101, 2018 WL 3268723, at *12-13 (July 3, 2018)
(footnote omitted).8
Regarding Charles Cathcart, the joint stipulations provide: “Charles Cathcart, as
founder, owner, President, and marketer of the program, participated directly in its
organization and sale. Cathcart has been involved in ‘the 90% Loan Program from the
beginning’ and ‘designed it.’” The joint stipulations also state that
Cathcart made and caused to be made several false or fraudulent
statements with respect to the tax benefits of the 90% Loan Program.
Cathcart oversaw and actively participated in Derivium’s marketing efforts.
As “president of Derivium Capital, LLC,” he “had overall responsibility for
the management of its role in the transaction which was the marketing and
sales and the loan administration.” Thus, among other things, Cathcart
participated in the training of Derivium’s sales staff and edited and approved
marketing materials and tax memos that were distributed to clients.
8The court notes that the plaintiffs in Raifman v. Commissioner, Gregory Raifman and
Susan Raifman, are the same plaintiffs as in the previously filed case of Raifman v. Wells
Fargo Advisors, LLC, Case No. C 11-02885 SBA, 2014 WL 12013436 (N.D. Calif. March
31, 2014). As explained by the United States Tax Court in Raifman v. Commissioner:
Following the complete collapse of Derivium and all associated entities, the
Raifmans, joined by a number of other former Derivium participants,
attempted to sue Wachovia for its role in facilitating the transfer of
participants' shares to Derivium. On March 31, 2014, the U.S. District Court
for the Northern District of California dismissed the participants’ claims. In
May of 2016, the Court of Appeals for the Ninth Circuit affirmed the
judgment of the District Court.
Raifman v. Comm’r, 2018 WL 3268723, at *10.
6
The joint stipulations further indicate that “[f]or over a decade, Cathcart presided over a
scheme marketed in significant part for its purported tax benefits. During this period,
Cathcart edited and even authored tax memos that falsely touted the scheme’s tax
benefits – even after he was advised by a law firm that the 90% Loan Program likely
violates the tax laws.”
The parties before this court stipulate that:
Cathcart knew that the 90% Loan scheme operated by selling the
customers’ securities immediately upon receipt (“on behalf of” sham
“lenders” Cathcart created), retaining 10% of the proceeds as income in
Derivium-controlled bank and brokerage accounts, and then distributing the
proceeds to Cathcart and his associates directly and to the Start-Up
Companies (which Cathcart and his associates owned and manage).
The parties’ joint stipulations also indicate that “Cathcart had actual knowledge that
the customers’ securities were not ‘held’ but were rather sold immediately,” and “Cathcart
also knew or had reason to know that no ‘hedging’ took place and that the 90% Loan
transactions were taxable sales. Cathcart is a Ph.D. economist who spent years working
on actual derivatives and hedging instruments before creating the 90% Loan Program.”
Moreover, “[b]ased on the absence of actual hedging, Cathcart had reason to know
Derivium would lack the funds to perform on (and thus would default on) its obligation to
return customers’ securities upon demand at maturity.” The parties further stipulate that:
Cathcart has taken repeated steps to obfuscate the true nature of and his
role in certain aspects of the scheme. He has falsified or caused to be
falsified documents from the purported lenders, created artificial foreign
entities to act as “lenders” and as the “owners” of the scheme’s proceeds,
and continues to deny any involvement in the “foreign lenders” participation
in the scheme.
The parties stipulate that “Cathcart knew or had reason to know that the 90% Loan
Program’s claims were false or fraudulent under Section 6700 [26 U.S.C. § 6700].” In
addition, the parties’ joint stipulations indicate that: “As the scheme’s founder, creator,
and President, and as the alter ego of all of the sham ‘foreign lenders,’ Cathcart knew
that several of the scheme’s claims were false or fraudulent.” (emphasis in original). As
the United States Tax Court in Raifman noted, “[o]n March 5, 2010, Mr. Cathcart, the
principal of the Derivium program, was permanently enjoined from promoting it, as it
constituted an abusive tax shelter.” Raifman v. Comm’r, 2018 WL 3268723, at *11.9
9 The Tax Court noted in a footnote that in “September 2005, Derivium had filed a
voluntary petition for chapter 11 bankruptcy protection.” Raifman v. Comm’r, T.C.M. 2018-
101, 2018 WL 3268723, at *11 n.26.
7
The Plaintiffs
Plaintiff Jon A. Rochlis testified that he attended the Massachusetts Institute of
Technology, and received a computer science/computer engineering degree in 1985. Jon
A. Rochlis testified that “I went to Boston University for a certificate in financial planning,
I think it was year 2000, late 1990s/2000. And I have a J.D. degree from the University of
New Hampshire Law School from 2011.” He testified that the between 1990 and 1991,
he purchased 225 shares of Cisco stock for approximately $10,000. At trial, he stated: “I
invested about $10,000 in Cisco that became about $2 million - worth about $2 million
about ten years later.” He further testified “I invested in a number of stocks. The ones
relevant to this case include Network Appliance, Internet Security Systems, Amazon.com,
Intel, Microsoft.”
In the second amended complaint in Case No. 16-200T, the Rochlises10 allege
“[i]n reliance on the false pretenses regarding Derivium's hedging strategy, the Rochlises
signed the Master Loan Agreement to Provide Financing and Custodial Services directly
with Charles Cathcart” in 2000. The Master Loan Agreement signed by Jon A. Rochlis11
stated in part:
10 Although the plaintiffs in Case No. 16-200T are Jon A. Rochlis and Anne R. LaVin, and
the plaintiffs’ complaint and amended complaints refer to Jon A. Rochlis and Anne R.
LaVin together as the “Rochlises,” the court notes, however, only Jon A. Rochlis signed
the Master Loan Agreement with Derivium. In addition, only Jon A. Rochlis testified for
the plaintiffs in Case No 16-200T, as Anne R. LaVin did not testify at the trial. Similarly,
as discussed below, although the plaintiffs in Case No. 16-210T are Kenneth Ishii and
Sheryl A. Ishii, and the plaintiffs’ complaint and amended complaints refer to Kenneth Ishii
and Sheryl A. Ishii together as the “Ishiis,” the court notes, however, only Kenneth Ishii
signed the Master Loan Agreement with Derivium. In addition, only Kenneth Ishii testified
for the plaintiffs in Case No 16-210T, as Sheryl A. Ishii did not testify at the trial. Regarding
Irene M. Warren, although Irene M. Warren signed the Master Loan Agreement with
Derivium, she passed away before suit was filed in this court, and the plaintiff in Case No.
201T is listed in the caption of the second amended complaint as “Jon Rochlis as
Executor of the Estate of Irene M. Rochlis (aka Warren),” and Irene M. Warren did not
testify at trial.
11 The Master Loan Agreement signed by Jon A. Rochlis is substantially similar to the
Master Loan Agreement signed by Irene M. Warren and Kenneth Ishii. As discussed
below, the termination provisions were different in all three Master Loan Agreements. The
other differences between the three Master Loan Agreements are the terms of the
Schedules attached to the Master Loan Agreements identifying the securities transferred
to Derivium. In addition, Kenneth Ishii’s Master Loan Agreement was entered into with
First Security Capital L.L.C, and not Derivium Capital, LLC.
8
1. SERVICES TO BE PROVIDED BY DC
DC [Derivium Capital, LLC] is hereby appointed Custodian of the Properties
and authorized to act on behalf of the Client with respect to the Properties
for the purposes of:
a) Providing or arranging financing by way of one or more loans (the
“Loan(s)”) in accordance with terms to be agreed upon by the parties and
set out in loan term sheets and attached hereto as Schedule(s) A.
b) Holding cash, securities, or other liquid amounts (the “Client Liquid
Assets”) on behalf of the Client and acceptable to DC as collateral.
c) Voting shares and receiving dividends or interest on securities held as
collateral.
2. AMOUNT & TERMS OF FINANCING
The terms of each Loan are hereby contained in the attached Schedule(s)
A. The exact loan amounts will be based upon loan-to-value considerations
and the results of due diligence. The net loan proceeds may be distributed
at one time or on sequential dates, as instructed by Client.
3. FUNDING OF LOAN
The contemplated Loan(s) will be funded according to the terms identified
in one or more terms sheets, which be labeled as Schedule A, individually
numbered and signed by both parties, and, on signing, considered part of
and merged into this Master Agreement. The Client understands that by
transferring securities as collateral to DC and under the terms of the
Agreement, the Client gives DC and/or its assigns the right, without
requirement of notice to or consent of the Client, to assign, transfer, pledge,
repledge, hypothecate, rehypothecate, lend, encumber, short sell, and/or
sell outright some or all of the securities during the period covered by the
loan. The Client understands that DC and/or its assigns have the right to
receive and retain the benefits from any such transactions and that the
Client in not entitled to these benefits during the term of a loan. The Client
agrees to assist the relevant entities in completing all requisite documents
that may be necessary to accomplish such transfers.
4. RETURN OF CLIENT COLLATERAL
DC agrees to return, at the end of the loan term, the same number of shares
of the same securities received as collateral (as conditioned in the next
sentence), as set out and defined in Schedule(s) A attached hereto, upon
the Client satisfying in full all outstanding loan balances, including accrued
9
interest. Said collateral shall reflect any and all stock splits, conversions,
exchanges, mergers, or other distributions, except cash dividends credited
toward interest due.
...
7. INDEMNITY
DC makes no warranties regarding DC’s ability to fund or find a funder. Final
terms of each Loan(s) shall be negotiated and set out in separate Loan term
sheets to be attached as Schedule(s) A. Neither party is bound to any one
Loan until both parties have i) executed both the MLA and the Schedule A
for that Loan; ii) the Client has delivered acceptable shares; and iii) DC has
initiated the establishment of hedging transactions for that Loan.
(capitalization and emphasis in original). A difference between the multiple plaintiffs’
Master Loan Agreements was the termination clause at paragraph 13. Jon A. Rochlis’
Master Loan Agreement12 at paragraph 13(b) stated:
This Agreement may be terminated by either party at any time prior to the
funding of a loan, in whole or in part and as cash or as credit to cover any
existing obligations. At any time the Client can request that any collateral
not yet committed in a DC hedging transaction be promptly returned
resulting in the reductions of the amount and terms of the loan.
Irene M. Warren’s termination clause stated at 13(b): “This Agreement may be terminated
by either party at any time prior to the funding of a loan, in whole or in part and as cash
or as credit to cover any existing obligations.” As indicated above, Irene M. Warren signed
the Master Loan Agreement with Derivium in 2000. Kenneth Ishii’s termination clause13
stated at 13(b):
This Agreement may be terminated by either party at any time prior to the
funding of a loan, in whole or in part and as cash or as credit to cover any
existing obligations. At any time the Client can request that any collateral
not yet committed in an FSC hedging transaction be promptly returned
resulting in the reduction of the amount and terms of the loan.
Schedule A to Jon A. Rochlis’ Master Loan Agreement provides that the Rochlises
transferred the following securities to Derivium between February and May of 2000:
12 As indicated above, only Jon A. Rochlis signed his Master Loan Agreement.
13 As indicated above, in the exhibits provided by the parties, only Kenneth Ishii signed
his Master Loan Agreement.
10
Stock14 Transfer Date Shares Value as Assigned by Derivium
AMZN As of February 23, 2000 2,000 $140,870.00
CSCO As of February 23, 2000 4,000 $554,500.00
CSCO As of May 23, 2000 15,000 $758,203.00
INTC As of May 23, 2000 1,200 $131,850.00
ISSX As of February 25, 2000 2,000 $198,250.00
MSFT As of May 23, 2000 1,500 $94,781.00
NTAP As of February 25, 2000 1,000 $205,438.00
Total Securities $2,083,892.00
In response to plaintiffs’ counsel’s question “in 1999, 2000, why was a hedging
strategy important to you?” Mr. Rochlis testified
you asked me about did I believe that these companies would continue to
increase in value, and I certainly did believe that, but they had increased in
value so much, as you can see from the numbers, so recently, that I was
concerned that the volatility would be high, that we might see a downturn
for a while, we might see an up - I didn’t really know how to judge it, but I
had such - such gains that I felt I needed to try to secure those, but I also
wanted to participate in what I saw as the Internet future.
Mr. Rochlis testified that he first learned of Derivium Capital in “an advertisement
in the Wall Street Journal for their 90 percent stock loan.” He testified that “Randolph
Anderson was the person who responded to me and was the sales/marketing person at
Derivium” and that he received “brochures and emails from Mr. Anderson in January of
1999.”15 Mr. Rochlis testified as to what he believed was the advantage of pursing the
stock loan with Derivium,
one of their attributes that they touted was that you own the stock. You still
own your stock. You transfer it to them in escrow, and they hold it, but you
still own it. Therefore, you - you benefit from - from - from an unlimited
14 AMZN is the stock symbol for Amazon.com, Inc. CSCO is the stock symbol for Cisco
Systems, Inc. INTC is the stock symbol for Intel Corporation. ISSX is the stock symbol for
Internet Security Systems. MSFT is the stock symbol for Microsoft Corporation. NTAP is
the stock symbol for NetApp Inc.
15 Mr. Rochlis testified that one of the emails between Mr. Rochlis and Mr. Anderson
referred to Mr. Rochlis’ mother because she was “also interested in a Derivium
transaction and was - was considering that, and this is asking Derivium to work up
whether they can do it for these stocks and the terms and the like for - for actually two
different loan scenarios. She only actually entered into one later” in 2000. As the parties
jointly stipulate, “Irene M. Rochlis (aka Warren) passed away on March 13, 2011. Jon A.
Rochlis, her son, was appointed as the Executor of her Estate.” “Jon A. Rochlis as the
Executor of the Estate of Irene M. Rochlis (aka Warren)” is listed as the plaintiff in the
second amended complaint in Case No. 16-201T.
11
upside potential, which, of course, is marketing-speak, but you gain from
the upside potential, again, minus the cost of the loan, but you have upside
potential. It’s designed that way.
Mr. Rochlis continued: “So the Derivium hedge worked in that you gave them security for
a loan that was in the amount of 90 percent of the value when you transferred the
securities, and they promised to deliver those securities to you in three years if you paid
off the loan plus - plus interest.” Regarding the arrangement with Derivium, Mr. Rochlis
believed “[t]here was a term - there was a term of the agreement that said until they
performed the hedge, we could demand our collateral back. Once they had done the
hedge, we couldn’t do it. Then we were locked into the three years.”
Mr. Rochlis explained at trial why he decided to move forward with Derivium, first,
indicating that he “wouldn’t have done it without the marketing brochures, particularly
Charles Cathcart’s experience in creating derivatives, because you couldn’t just buy this
off the shelf.” In response to plaintiffs’ counsel’s question: “So what were the advantages
of the model proposed by Charles Cathcart?” Mr. Rochlis testified
the advantages are you have got downside protection of 90 percent, you
had upside potential if the stock rose above 120 percent of the value when
you went into it, which, as you - as I have said, the stocks had certainly done
- shown their ability to do that in the past. It was also somewhat less
expensive than publicly traded options, and the term was for three years,
and it was easy to do, where you didn't have three-year options, and so you
had to keep rolling over the stock - the options, rather, when they expired
every six months or something like that, which was a - would have been a
lot of work and possibly more expensive as the stock prices would - would
fluctuate.
Regarding the failure of Derivium to complete the transaction, plaintiffs’ counsel
asked Mr. Rochlis, “[w]hen did you find out that they hadn’t done the hedge?” and Mr.
Rochlis responded that “[y]ou and some other attorneys contacted me in late 2012, early
2013.” Mr. Rochlis testified that “Randolph Anderson represented to me that they would
not sell the stock without hedging it. As a matter of fact, I think he said they would be
crazy or insane. That's a conversation I remember pretty well for how long ago it was.”
Mr. Rochlis continued: “And similarly, I got comfortable with Derivium doing that because
they were the derivatives and hedging gurus and experts, and they admitted that it would
be crazy to sell the stock without putting a hedge in place.” Mr. Rochlis testified in
response to the question, “[w]hy did you file your theft loss claim [with the IRS] in 2009?”
“because that was the first year, given the stipulations, that we could have known that
there was actual - there was an actual mens rea, there was an actual intent, scienter on
the part of Cathcart to steal - to fraudulently deprive us of our property.” Mr. Rochlis
testified that “Derivium never told us that they had assigned, pledged, sold, or anything
to the collateral. They gave us statements every quarter for the duration showing how
many shares they were holding for us. In fact, those were adjusted for splits. They showed
dividends. That reduced interest.” Mr. Rochlis continued:
12
They expressly promised to me that they would not sell my securities
without a hedge, but they did, and so they robbed me of the upside potential
of my stocks, and they did that the first day when they sold my shares in
order to give me the 90 percent. They led me to believe that they would hold
those shares or that they would hedge them. They didn’t do that.
Regarding the tax implications, Mr. Rochlis testified that in
2003, when - when we defaulted on the loans, we reported a capital - a
gain, a recognition event, with gross proceeds of the 90 percent that we had
received, plus the roughly 30 percent - a little bit more because it was 10
1/2 percent a year - of interest as part of the gross proceeds, as cancellation
of debt income, as Attorney Byrnes advised us and also advised us that it
would be of capital gain character.
Mr. Rochlis also testified at the trial that he consulted an attorney about the
Derivium transaction, Mr. Daniel Byrnes, “in late 1999.” Mr. Byrnes conveyed to Mr.
Rochlis that
in his opinion, they were not constructive sales; they were loans. He advised
us that - because I wanted to understand what our obligations were and our
obligations, in the event that we wound up eventually defaulting on the
loans, what also - what we would report when that happened, and he
advised that at that point we would have a recognition event that was - with
a gross proceeds of the 90 percent that we had obtained in cash, plus the
accrued interest that we had not paid as a cancellation of debt income.
On cross-examination, Mr. Rochlis testified that the only personal property that he
owned that was transferred to Derivium was the stock. In response to the government’s
question: “But you never made any attempt to get any of your collateral back at any time
until the end of the loan term?” Mr. Rochlis responded: “That’s correct.”
In addition, regarding the upside potential if the stock rose above 120 percent of
the value of the securities,16 defendant’s counsel asked Mr. Rochlis on cross-
examination, “[a]nd, in fact, you never sought to exercise that right under the contract,
correct?” To which Mr. Rochlis responded: “I did not.” Defendant’s counsel continued:
“And that’s because, in your case, none of the stocks were worth - had appreciated more
than 120 percent of their original value.” Mr. Rochlis responded that “at the end of the
term, that was the case. The first day, when they stole the stock, that was not the case.”
Mr. Rochlis statement at trial about stealing led to this exchange with defendant’s counsel:
“But if they stole the stock on day one, then there is no potential appreciation, is there?
16 Mr. Rochlis testified at trial that he had the option to have his stock returned to him if
he had paid the principal plus interest, or approximately 120 percent of the value of the
stock. Schedule A to the Master Loan Agreements provides that the interest rate for the
loans was “10.50%, compounded annually, accruing until and due at maturity.”
13
Your property has been stolen. You would have the right to get your property back. The
potential appreciation would only exist with regard to what might happen down the road.”
Mr. Rochlis responded:
That’s - well, that’s - no, the contractual obligation is to provide the financial
equivalent of a call option, and they didn’t do that. They didn’t do that. Why
didn’t they do that? They didn’t do that because they sold the stock without
engaging in the hedging transactions that they represented they would. Had
they done that, they could have delivered.
At trial, Mr. Rochlis and defendant’s counsel discussed at some length the decision to
exercise the option to surrender the various stocks.17 Defendant’s counsel identified for
Mr. Rochlis four documents that Mr. Rochlis had signed, in each one, choosing the option
“I/we hereby officially surrender my/our collateral in satisfaction of my/our entire debt
obligation,” instead of “I/we will be paying off my/our loan and request the return of my/our
collateral,” or “I/we would like to renew or refinance this transaction for an additional term
of 3 years.” For the three loans with maturity dates of March 16, 2003, Mr. Rochlis
exercised the surrender option on February 3, 2003, and for the loan with the maturity
date of March 23, 2003, Mr. Rochlis exercised the surrender option on March 11, 2003.
Although Mr. Rochlis signed the various documents selecting the option “I/we hereby
officially surrender my/our collateral in satisfaction of my/our entire debt obligation,” at
trial Mr. Rochlis contended “I will point out that I didn't voluntarily surrender it, as you
maintain, because they had already stolen it. I mean, you can't surrender something that
someone stole under false pretenses.”
Mr. Rochlis also testified that his mother, Ms. Irene M. Warren, “only wound up
doing one transaction with Derivium for about 3000 shares of Cisco stock, about $200,000
worth of Cisco stock.” Pursuant to the Master Loan Agreement, Irene M. Warren
transferred approximately $200,000 of Cisco stock to Derivium on June 7, 2000. In the
second amended complaint in Case No. 16-201T, alleges that “[i]n reliance on the false
pretenses regarding Derivium’s hedging strategy, Irene M. Rochlis signed the Master
Loan Agreement to Provide Financing and Custodial Services directly with Charles
Cathcart. Irene M. Rochlis parted with the following security by transferring it to Derivium
on June 7, 2000.”
Stock Transfer Date Shares Value as Assigned by Derivium
CSCO As of June 7, 2000 3,148 $197,931.00
Plaintiff Kenneth Ishii also testified at the trial. He testified that he attended the
Massachusetts Institute of Technology, and joined the company Accordance, and that “I
was around employee number 12.” Mr. Ishii received stock options and after he joined
Accordance it merged with Software.com in the “fall of 1986.” As a result, his Accordance
17 Mr. Rochlis testified: “That was for all of my loans, and my mother would have done the
same thing, and I’m sure you have a document in here about that as well, but if you don’t,
I'm sure she did.”
14
options “got rolled over into new options in Software.com.”18 At the time of his first
transaction with Derivium, Mr. Ishii testified that the value of the Software.com stock “was
probably on the order of 10 million [dollars] at that point.”
In the amended complaint in Case No. 16-210T, the Ishiis allege “[i]n reliance on
the false pretenses regarding Derivium’s hedging strategy, the Ishiis signed the Master
Loan Agreement to Provide Financing and Custodial Services directly with Charles
Cathcart. The Ishiis parted with the following securities by transferring them to Derivium.”
Stock Transfer Date Shares Value as Assigned by Derivium
SWCM As of December 21, 1999 50,000 $4,800,000.00
SWCM As of January 10, 2000 28,000 $2,567,250.00
SWCM As of March 16, 2000 7,353 $944,861.00
SWCM As of September 20, 2000 11,024 $1,760,395.00
Total Securities $2,083,892.00
Mr. Ishii entered into an agreement with Derivium in December of 1999, and
explained at trial why the Derivium approach appealed to him:
Well, all of my net worth was tied up in Software.com, and I really - you
know, I had a young family and one on the way, and I wanted to protect
that. And, you know, I just - you know, we just couldn’t predict the future,
and so we wanted to make sure that we - you know, as - as the pitch was,
it was, you know, protect your downside and retain your upside. And that
sounded just - you know, just like what I wanted.
Mr. Ishii testified that, to his knowledge, there was not a hedge available to him for
Software.com, indicating that “my belief is that there – the stock was so new and so
volatile that there really wasn’t a market for it yet.”
Mr. Ishii testified that he learned of Derivium “[e]arly in 1999, Mr. Rochlis told me
about them,” and Mr. Ishii explained that he and Mr. Rochlis have been good friends since
approximately 1985. Mr. Ishii also testified “I also talked to Mr. Rochlis about, you know,
what he had done and what my options there were, and it didn't really sound like, sort of
on the public options market, there was any market for, you know, a brand new startup
like Software.com, so that didn't really seem to be a possibility.”
Regarding Derivium, Mr. Ishii explained, “I got standard marketing literature, and
then eventually I - I don’t remember how it was arranged, but I had a phone call with
Randolph Anderson, and we talked about the different programs they had available and
how - how they applied to my situation, and he described them, and - you know, and we
moved forward from there.” Mr. Ishii emphasized that Mr. Anderson explained “the tax
consequences of the event, and he said there were none. He also discussed how the 90
percent was an important number, because the 10 percent made it a significant risk, and
so it wasn't deemed a sale by the IRS.”
18 The stock symbol for Software.com, Inc. is SWCM.
15
At trial, Mr. Ishii gave his view on how the Derivium hedge would work:
My understanding was that they - they had someone - you know, they would
get the money together, and I would give them the stock, and they would
hedge however they were going to do, and whatever the value of that hedge
was, I would get 90 percent of that value as a loan for the - for three years.
And it was, you know, locked up for those three years, and it was
nonrecourse, and that over that time, it would be 10 1/2 percent interest per
year.
Mr. Ishii reiterated his belief that “I still continued to own the stock even though they held
it, and, you know, so there was no sale. There was - and at the end of the loan period, I
could pay back the loan, and I would get my stock back, and - and, you know, if it
increased in value, I would - you know, I would have that gain.” At trial, plaintiffs’ counsel
had Mr. Ishii read portions of the Master Loan Agreement between Mr. Ishii and Derivium.
Specifically, Mr. Ishii read paragraph 13(b) which stated:
This Agreement may be terminated by either party at any time prior to the
funding of a loan, in whole or in part and as cash or as credit to cover any
existing obligations. At any time the Client can request that any collateral
not yet committed in an FSC hedging transaction be promptly returned
resulting in the reduction of the amount and terms of the loan.
Mr. Ishii testified that “I believe this - this meant that they had to be able to return the stock
to me and up until the time it was hedged. So a hedge had to exist.” Mr. Ishii testified that
he entered four total hedges with Derivium. For each one he testified that he “believed
that they [Derivium] had hedged my stock, that they had entered into some contract
protecting it.”
In response to the question from plaintiffs’ counsel: “So what do you believe that
Derivium stole from you?” Mr. Ishii responded, “I believe they stole the upside on my
stock, that they really - you know, by selling it with no guaranteed way of getting it back,
at that point, it was - you know, if it had taken off, they were - I was - there was no way
for them to get it back for me.” In response to the question, “[d]o you recall having any
knowledge of any court decisions that have been entered or judgments entered in any of
the litigation against Derivium prior to 2009 that - where the Court found that Derivium
had committed fraud with respect to the 90 percent loan transaction?” Mr. Ishii responded:
“I do not believe I ever - I ever heard those - those things, so no.”
On cross examination, Mr. Ishii agreed that one of the advantages that Mr.
Anderson highlighted for Mr. Ishii was the ability to defer capital gains tax, and Mr. Ishii
further agreed he was able to defer capital gains tax with regard to the 90 percent cash
he received. Mr. Ishii also had the following exchange with defendant’s counsel on cross
examination:
16
Q. And then it’s protect your wealth, and this refers to significant losses can
come quickly and - in other words, that's the downside protection by cashing
out 90 percent of the value of your stock.
A. That looks like what that point’s about.
Q. And, in fact, you did get the downside protection, because you did cash
out 90 percent of the value of your stock.
A. Yes.
Q. Okay. And, in fact, there was volatility and there were, in fact, significant
losses incurred with respect to the Software.com stock that you transferred
to Derivium.
A. Yes, but I didn't know that at the time.
Q. But you were protected. If you had held your stock and it had gone down,
you would have lost a substantial portion of the gain that was built into that
stock, correct; in other words, your appreciation?
A. Yeah, well, depending on when I sold, I would have either gotten some
appreciation or lost some, depending.
Q. Okay. And if you had just sold it, you would, of course, had to have paid
tax on it at the time of that sale, correct?
A. Of course.
Like Mr. Rochlis, Mr. Ishii elected to surrender the collateral rather than pay the principal
and interest due on his loan. Defendant’s counsel asked Mr. Ishii on cross examination,
“because the stock was worth a tiny fraction of what the loan - the principal and interest
due on the loan was, you elected to surrender your stock and walk away from the deal?”
Mr. Ishii responded: “Yeah, I elected to - to surrender the collateral.” In response to the
question, “as a result of surrendering the collateral and walking away from the loan, you
were not required to make any payment to Derivium at the end of the transaction,” Mr.
Ishii responded: “Correct.” Mr. Ishii confirmed he repeated this process with all four of the
transactions, and agreed with defendant’s counsel that in “all the other instances, the
value of the stock was substantially less than what you would have had to have paid to
get it back.”
The plaintiffs all allege “they discovered that on November 19, 2009 Derivium’s
president, Charles Cathcart entered into a stipulation with the United States Department
of Justice that he acted with scienter in making false representations about the hedging
transaction and the 90% Stock Loan.” Regarding the Rochlises, the second amended
complaint in Case No. 16-200T alleges:
17
The Rochlises timely filed their protective claim on a 2009 1040X . . . to
report to the Derivium theft loss on July 22, 2013 under the three year
statute of limitations under I.R.C. § 6511(a). Once they received the expert
report from Moss Adams, they timely filed their 2009 1040X on September
9, 2014 to report their theft loss of $896,308. On their 2009 1040X the
Rochlises requested a tax refund of $4,873.00
Regarding Irene M. Warren, the second amended complaint in Case No. 16-201T
similarly alleges that
The Estate of Irene M. Rochlis timely filed a protective claim on a 2009
1040X . . . to report to the Derivium theft loss on July 22, 2013 under the
three year statute of limitations under I.R.C. § 6511(a). Once the estate
received the expert report from Moss Adams, the Executor timely filed a
2009 1040X on September 9, 2014 to report theft loss of $75,672. The
Estate of Irene M. Rochlis requested a tax refund of $19,519.
Regarding the Ishiis, the amended complaint in Case No. 16-210T alleges, “[t]he
Ishiis timely filed their protective claim on a 2009 1040X . . . to report to the Derivium theft
loss on July 22, 2013 under the three year statute of limitations under I.R.C. § 6511(a),”
and “[t]he Ishiis have satisfied the requirements of I.R.C. § 7422(a) because more than
six months have elapsed since said Claim for Refund was filed and said Claim has neither
been allowed nor disallowed by the Internal Revenue Service.” The amended complaint
in Case No. 16-210T indicated that the Ishiis also engaged Moss Adams LLP “to provide
an expert opinion on the valuation of the options to repurchase the stock.”
All plaintiffs argue that they can prove they are victims of theft loss, because
Charles Cathcart made false statements which he knew were false, he made those false
statements with the intent that the plaintiffs should rely on them, that the plaintiffs did rely
on them, and plaintiffs parted with their personal property as a result. In the amended
complaints, separate from the lower amounts they claimed on their 2009 Forms 1040X,
the Rochlises sought judgment in the amount of $68,703.00,19 the Ishiis sought a
19The Rochlises included the following table in the second amended complaint for Case
No. 16-200T:
Tax Year Refund
2009 $4,873
2006 $21,645
2007 $10,161
2008 $8,885
2010 $2,063
2011 $0
2012 $19,598
2013 $1,478
$68,703
18
judgment in the amount of $208,344.00,20 and the Estate of Irene Rochlis sought
judgment in the amount of $19.519.00.21
As indicated above, trial was held, the parties submitted post-trial briefs and the
court held closing argument. The parties subsequently submitted supplemental briefs to
address the issues the court identified at closing argument.
DISCUSSION
Plaintiffs seek tax refunds for alleged theft losses for the Derivium fraud.22 As noted
above, the plaintiffs sought to amend their 2009 taxes by filing Forms 1040X in 2013. The
Rochlises seek a cumulative tax refund in the amount of $68,703.00, Irene M. Warren
seeks a tax refund of $19.519.00, and the Ishiis seek a cumulative tax refund in the
amount of $208,344.00. The United States Supreme Court has stated that: “A taxpayer
seeking a refund of taxes erroneously or unlawfully assessed or collected may bring an
action against the Government either in United States district court or in the United States
Court of Federal Claims.” United States v. Clintwood Elkhorn Mining Co., 553 U.S. 1, 4
(2008) (citing both 28 U.S.C. § 1346(a)(1) and EC Term of Years Trust v. United States,
550 U.S. 429, 431, & n.2 (2007)); see also Manor Care, Inc. v. United States, 89 Fed. Cl.
20 The Ishiis included the following table in the amended complaint for Case No. 16-210T:
Tax Year Refund
2009 $0
2006 $27,076
2007 $62,329
2008 $30,353
2010 $7,635
2011 $38,925
2012 $42,026
Total Tax Refund $208,344
21Unlike the Rochlises and the Ishiis, Irene M. Warren did not include a table in the
second amended complaint in Case No. 16-201T, and only requested a tax refund in the
amount of $19.519.00 for tax year 2009.
22 Plaintiffs Jon A. Rochlis, Anne R. LaVin, and Irene M. Warren filed one, common post-
trial brief and plaintiffs Kenneth Ishii and Sheryl Ishii filed a separate post-trial brief. As
defendant notes in its post-trial brief, “[a]n examination of the two briefs reveals that other
than the factual statements and different stock values used in the expert’s reports, the
arguments advanced in each of the two briefs are the same.” This is consistent with the
plaintiffs’ approach to the trial. As noted above, the court generically refers to all the
plaintiffs as “the plaintiffs,” but specifically identifies individual plaintiffs by name when
discussing specific transactions, or when otherwise appropriate.
19
618, 622 (2009) (citing Flora v. United States, 362 U.S. 145, 177, reh’g denied, 362 U.S.
972 (1960)); Shore v. United States, 9 F.3d 1524, 1527 (Fed. Cir. 1993) and 28 U.S.C. §
1346(a)), aff’d, 630 F.3d 1377 (Fed. Cir. 2011); Strategic Hous. Fin. Corp. v. United
States, 86 Fed. Cl. 518, 530 (citing United States v. Clintwood Elkhorn Mining Co., 553
U.S. at 4), motion to amend denied, 87 Fed. Cl. 183 (2009), aff’d in part, vacated in part
on other grounds, 608 F.3d 1317 (Fed. Cir. 2010), cert. denied, 131 S. Ct. 1513 (2011);
Buser v. United States, 85 Fed. Cl. 248, 256 (2009) (“It is ‘undisputed’ that the Court of
Federal Claims possesses the authority to adjudicate tax refund claims.”) (citations
omitted); RadioShack Corp. v. United States, 82 Fed. Cl. 155, 158 (2008) ("This Court
has jurisdiction to consider tax refund suits under 28 US.C. § 1491(a)(1).”) (citations
omitted), aff’d, 566 F.3d 1358 (Fed. Cir. 2009).
Section 1346 of Title 28 of the United States Code provides that:
(a) The district courts shall have original jurisdiction, concurrent with the
United States Court of Federal Claims, of: (1) Any civil action against the
United States for the recovery of any internal revenue tax alleged to have
been erroneously or illegally assessed or collected, or any penalty claimed
to have been collected without authority or any sum alleged to have been
excessive or in any manner wrongfully collected under the internal revenue
laws. . . .
28 U.S.C. § 1346(a)(1) (2018).
For this court to exercise its jurisdiction over plaintiffs’ federal tax refund claim, a
petitioning party must first satisfy the tax refund schematic detailed in Title 26 of the
Internal Revenue Code, which establishes that a claim for refund must be filed with the
IRS before filing suit in federal court, and establishes strict deadlines for filing such claims.
See 26 U.S.C. §§ 6511, 7422 (2018).23 In United States v. Clintwood Elkhorn Mining Co.,
the United States Supreme Court indicated that:
A taxpayer seeking a refund of taxes erroneously or unlawfully assessed or
collected may bring an action against the Government either in United
States district court or in the United States Court of Federal Claims. The
23 The statute at 26 U.S.C. § 7422(a) states:
No suit or proceeding shall be maintained in any court for the recovery of
any internal revenue tax alleged to have been erroneously or illegally
assessed or collected, or of any penalty claimed to have been collected
without authority, or of any sum alleged to have been excessive or in any
manner wrongfully collected, until a claim for refund or credit has been duly
filed with the Secretary, according to the provisions of law in that regard,
and the regulations of the Secretary established in pursuance thereof.
26 U.S.C. § 7422(a).
20
Internal Revenue Code specifies that before doing so, the taxpayer must
comply with the tax refund scheme established in the Code. That scheme
provides that a claim for a refund must be filed with the Internal Revenue
Service (IRS) before suit can be brought, and establishes strict timeframes
for filing such a claim.
United States v. Clintwood Elkhorn Mining Co., 553 U.S. at 4 (citations omitted); see also
RadioShack Corp. v. United States, 566 F.3d 1358, 1360 (Fed. Cir. 2009) (“[I]n the
context of tax refund suits, the [Supreme] Court has held that the Court of Federal
Claims's Tucker Act jurisdiction is limited by the Internal Revenue Code, including 26
U.S.C. § 7422(a).”); United States v. Dalm, 494 U.S. 596, 609-10, reh’g denied, 495 U.S.
941 (1990); Buser v. United States, 85 Fed. Cl. at 256. Moreover, for a refund claim, the
court only may hear claims for which the petitioning taxpayer has fulfilled all of his or her
tax liabilities for the tax year in question before the refund claim is heard. Flora v. United
States, 357 U.S. 63, 72-73 (1958) (Flora I), aff’d on reh’g, 362 U.S. 145 (Flora II), reh’g
denied, 362 U.S. 972 (1960). In Flora II, the United States Supreme Court reiterated that
28 U.S.C. § 1346(a)(1) requires “payment of the full tax before suit. . . .” Flora II, 362 U.S.
at 150-51; see also Computervision Corp. v. United States, 445 F.3d 1355, 1363 (Fed.
Cir.), reh’g and reh’g en banc denied, 467 F.3d 1322 (Fed. Cir. 2006), cert. denied, 549
U.S. 1338 (2007); Shore v. United States, 9 F.3d at 1526 (“The full payment requirement
of Section 1346(a)(1) and Flora applies equally to tax refund suits brought in the Court of
Federal Claims. . . .”) (citations omitted).
Essentially, section 7422(a) functions as a waiver of the government’s sovereign
immunity in tax refund suits. Chicago Milwaukee Corp. v. United States, 40 F.3d 373, 374
(Fed. Cir. 1994), reh’g and reh’g en banc denied, 141 F.3d 1112 (Fed. Cir.), cert. denied,
525 U.S. 932 (1998); see also Gluck v. United States, 84 Fed. Cl. 609, 613 (2008).
“[S]ection 7422(a) creates a jurisdictional prerequisite to filing a refund suit.” Id. (citing
Chicago Milwaukee Corp. v. United States, 40 F.3d at 374 (citing Burlington N., Inc. v.
United States, 231 Ct. Cl. 222, 684 F.2d 866, 868 (1982))). Once a party has established
compliance with 26 U.S.C. § 7422(a), the party may, if successful, also recover interest
for its refund claim. See Deutsche Bank AG v. United States, 95 Fed. Cl. 423, 427 n.3
(2010) (citing Brown & Williamson, Ltd. v. United States, 231 Ct. Cl. 413, 688 F.2d 747,
752 (1982)) (“There is no question, however, that this court has subject matter jurisdiction
under the Tucker Act, 28 U.S.C. § 1491 (2006), over claims, such as the present one,
seeking to recover statutory interest on income tax refunds.”).
Furthermore, as noted above, in order for a tax refund case to be duly filed in a
federal court pursuant to section 7422(a), the filing must comply with the timing
requirements set forth in 26 U.S.C. § 6511(a):
The basic rule of federal sovereign immunity is that the United States cannot
be sued at all without the consent of Congress. A necessary corollary of this
rule is that when Congress attaches conditions to legislation waiving the
sovereign immunity of the United States, those conditions must be strictly
observed, and exceptions thereto are not to be lightly implied. When waiver
21
legislation contains a statute of limitations, the limitations provision
constitutes a condition on the waiver of sovereign immunity.
Block v. North Dakota ex rel. Bd. of Univ. and School Lands, 461 U.S. 273, 287 (1983);
see also Buser v. United States, 85 Fed. Cl. at 257. The applicable language of section
6511(a) states:
Claim for credit or refund of an overpayment of any tax imposed by this title
. . . shall be filed by the taxpayer within 3 years from the time the return was
filed or 2 years from the time the tax was paid, whichever of such periods
expires the later, or if no return was filed by the taxpayer, within 2 years
from the time the tax was paid. . . .
26 U.S.C. § 6511(a); see also Treas. Reg. § 301.6511(a)-1 (2019) (“In the case of any
tax. . . . If a return is filed, a claim for credit or refund of an overpayment must be filed by
the taxpayer within 3 years from the time the return was filed or within 2 years from the
time the tax was paid, whichever of such periods expires the later.”). As articulated by the
United States Supreme Court in Commissioner v. Lundy, 516 U.S. 235 (1996):
A taxpayer seeking a refund of overpaid taxes ordinarily must file a timely
claim for a refund with the IRS under 26 U.S.C. § 6511. That section
contains two separate provisions for determining the timeliness of a refund
claim. It first establishes a filing deadline: The taxpayer must file a claim for
a refund “within 3 years from the time the return was filed or 2 years from
the time the tax was paid, whichever of such periods expires the later, or if
no return was filed by the taxpayer, within 2 years from the time the tax was
paid.” 26 U.S.C. § 6511(b)(1) (incorporating by reference 26 U.S.C. §
6511(a)). It also defines two “look-back” periods: If the claim is filed “within
3 years from the time the return was filed,” ibid., then the taxpayer is entitled
to a refund of “the portion of the tax paid within the 3 years immediately
preceding the filing of the claim.” 26 U.S.C. § 6511(b)(2)(A) (incorporating
by reference 26 U.S.C. § 6511(a)). If the claim is not filed within that 3-year
period, then the taxpayer is entitled to a refund of only that “portion of the
tax paid during the 2 years immediately preceding the filing of the claim.” 26
U.S.C. § 6511(b)(2)(B) (incorporating by reference § 6511(a)).
Comm’r v. Lundy, 516 U.S. at 239-40 (footnote omitted); see also United States v.
Clintwood Elkhorn Mining Co., 553 U.S. at 8 (determining that the language of section
6511(a) clearly states that taxpayers “must comply with the Code's refund scheme before
bringing suit, including the requirement to file a timely administrative claim.”). The
Supreme Court in Lundy also noted that a timely filing was a prerequisite for the United
States Court of Federal Claims to have jurisdiction for a refund claim. See Comm’r v.
Lundy, 516 U.S. at 240.
In sum, Congress has provided strict statutory guidelines laying out the statute of
limitations for the filing of a federal tax refund claim:
Read together, the import of these sections is clear: unless a claim for
refund of a tax has been filed within the time limits imposed by § 6511(a), a
22
suit for refund, regardless of whether the tax is alleged to have been
“erroneously,” “illegally,” or “wrongfully collected,” §§ 1346(a)(1), 7422(a),
may not be maintained in any court.
United States v. Dalm, 494 U.S. at 602.
Under the United States Tax Code, at 26 U.S.C. § 165, titled: “Losses,” “[t]here
shall be allowed as a deduction any loss sustained during the taxable year and not
compensated for by insurance or otherwise.” 26 U.S.C. § 165(a) (2018). The Tax Code
specifically provides for a theft loss, and states that “[f]or purposes of subsection (a), any
loss arising from theft shall be treated as sustained during the taxable year in which the
taxpayer discovers such loss.” 26 U.S.C. § 165(e). Treasury Regulations § 1.165-8(a),
titled: “Theft losses,” states:
Allowance of deduction. (1) Except as otherwise provided in paragraphs (b)
and (c) of this section, any loss arising from theft is allowable as a deduction
under section 165(a) for the taxable year in which the loss is sustained. See
section 165(c)(3).
(2) A loss arising from theft shall be treated under section 165(a) as
sustained during the taxable year in which the taxpayer discovers the loss.
See section 165(e). Thus, a theft loss is not deductible under section 165(a)
for the taxable year in which the theft actually occurs unless that is also the
year in which the taxpayer discovers the loss. However, if in the year of
discovery there exists a claim for reimbursement with respect to which there
is a reasonable prospect of recovery, see paragraph (d) of § 1.165–1.
(3) The same theft loss shall not be taken into account both in computing a
tax under chapter 1, relating to the income tax, or chapter 2, relating to
additional income taxes, of the Internal Revenue Code of 1939 and in
computing the income tax under the Internal Revenue Code of 1954. See
section 7852(c), relating to items not to be twice deducted from income.
Treas. Reg. § 1.165-8(a) (2019).24
24 Treasury Regulation § 1.165-8(b)-(c) provide:
(b) Loss sustained by an estate. A theft loss of property not connected with
a trade or business and not incurred in any transaction entered into for profit
which is discovered during the settlement of an estate, even though the theft
actually occurred during a taxable year of the decedent, shall be allowed as
a deduction under sections 165(a) and 641(b) in computing the taxable
income of the estate if the loss has not been allowed under section 2054 in
computing the taxable estate of the decedent and if the statement has been
filed in accordance with § 1.642(g)–1. See section 165(c)(3). For purposes
of determining the year of deduction, see paragraph (a)(2) of this section.
23
According to the definition of theft loss, Treasury Regulation § 1.165-8, provides
“[f]or purposes of this section the term ‘theft’ shall be deemed to include, but shall not
necessarily be limited to, larceny, embezzlement, and robbery.” Treas. Reg. § 1.165-8(d).
The term “theft” does not have a more specific definition in the Tax Code or in the
Treasury Regulations. See Adkins v. United States, 113 Fed. Cl. 797, 804 (2013)
(“Neither IRC § 165 nor its implementing regulations provide any further guidance for
what constitutes a theft.”) (footnote omitted). As noted by a Judge of this court:
The regulations, however, stop there in terms of providing any further
guidance on how to determine whether particular conduct amounts to “theft”
or any one of these other enumerated crimes. Like the parties here, many
cases seek further guidance on this point from state law, often citing
Edwards v. Bromberg, 232 F.2d 107, 111 (5th Cir. 1956), for the proposition
that “whether a loss from theft occurs within the purview of [section
165(c)(3)] . . . depends upon the law of the jurisdiction where it was
sustained.” From this point, many courts embark on an extended analysis
of whether the actions that occasioned the loss of funds constituted one of
the requisite theft crimes under state criminal laws.
Goeller v. United States, 109 Fed. Cl. 534, 539-40 (2013) (alterations in original) (footnote
omitted).
The parties agree that the burden of establishing that a deductible loss, including
that a theft loss occurred, rests with the plaintiffs. See Boehm v. Comm’r, 326 U.S. 287,
294 (1945) (“Here it was the burden of the taxpayer to establish the fact that there was a
deductible loss in 1937.”), reh’g denied, 326 U.S. 811 (1946); Krahmer v. United States,
810 F.2d 1145, 1147 (Fed. Cir. 1987) (recognizing the difficulty to prove intent using
circumstantial evidence in a theft loss deduction case, but holding that the United States
Claims Court did not place too high a burden of proof on a taxpayer to establish that a
deductible loss occurred); Jeppsen v. Comm’r, 128 F.3d 1410, 1418 (10th Cir. 1997)
(c) Amount deductible. The amount deductible under this section in respect
of a theft loss shall be determined consistently with the manner prescribed
in § 1.165–7 for determining the amount of casualty loss allowable as a
deduction under section 165(a). In applying the provisions of paragraph (b)
of § 1.165–7 for this purpose, the fair market value of the property
immediately after the theft shall be considered to be zero. In the case of a
loss sustained after December 31, 1963, in a taxable year ending after such
date, in respect of property not used in a trade or business or for income
producing purposes, the amount deductible shall be limited to that portion
of the loss which is in excess of $100. For rules applicable in applying the
$100 limitation, see paragraph (b)(4) of § 1.165–7. For other rules relating
to the treatment of deductible theft losses, see § 1.1231–1, relating to the
involuntary conversion of property.
Treas. Reg. § 1.165-8(b)-(c).
24
(noting that the plaintiff bears the burden of proving entitlement to a theft loss deduction),
cert. denied, 524 U.S. 916 (1998); Howard v. United States, 497 F.2d 1270, 1272 n.4 (7th
Cir. 1974) (“Plaintiffs, of course, had the burden of establishing that a theft occurred.”). If
a taxpayer is unable to establish the elements of the crime of theft under the applicable
state law, the taxpayer cannot be allowed a deduction under 26 U.S.C. § 165. The Federal
Circuit in Krahmer concluded that under 26 U.S.C. § 165, the “appropriate burden is proof
by a preponderance of the evidence.” Krahmer v. United States, 810 F.2d at 1147; see
also Bunch v. Comm’r, T.C.M. 2014-177, 2014 WL 4251136, at *6 (T.C. Aug. 28, 2014);
Marine v. Comm’r, 92 T.C. 958, 976 (1989); Allen v. Comm’r, 16 T.C. 163, 166, 1951 WL
73 (1951).
While a theft conviction may establish conclusively the existence of a theft under
26 U.S.C. § 165(e), the lack of such a conviction does not necessarily preclude a theft
loss deduction pursuant to 26 U.S.C. § 165(e), provided that the requisite specific intent
to deprive is present. See Vietzke v. Comm’r, 37 T.C. 504, 510 (1961) (holding that a theft
had occurred for purposes of 26 U.S.C. § 165(e), even though the alleged perpetrator of
the theft was not convicted of a theft crime).
The Treasury Regulations for theft loss provide that a plaintiff is not entitled to a
theft loss deduction until the plaintiff cannot demonstrate with reasonable certainty if a
possibly of recovery exists. Treasury Regulation § 1.165–1(d)(3) provides that
if in the year of discovery there exists a claim for reimbursement with respect
to which there is a reasonable prospect of recovery, no portion of the loss
with respect to which reimbursement may be received is sustained . . . until
the taxable year in which it can be ascertained with reasonable certainty
whether or not such reimbursement will be received.
Treas. Reg. § 1.165–1(d)(3) (2019); see also Jeppsen v. Comm’r, 128 F.3d at 1418 (10th
Cir. 1997) (noting taxpayers are “not entitled to take the theft loss deduction” in a year if
the “prospect of recovery was simply unknowable”); Adkins v. United States, 113 Fed. Cl.
at 807. The Treasury Regulations also state that “[w]hether a reasonable prospect of
recovery exists with respect to a claim for reimbursement of a loss is a question of fact to
be determined upon an examination of all facts and circumstances.” 26 C.F.R. § 1.165–
1(d)(2)(i); see also Adkins v. United States, 113 Fed. Cl. at 807; United States v. Elsass,
978 F. Supp. 2d 901, 915 (S.D. Ohio 2013) (“The Government . . . contends that the theft
losses claimed by the Defendants on behalf of their ABFS [American Business Financial
Services] customers were improper and ignored the legal requirements for § 165 theft-
loss deductions that the loss involve criminal intent and that the loss be claimed only after
the taxpayer can establish with reasonable certainty that no recovery will be made. The
Court agrees.”), aff’d, 769 F.3d 390 (6th Cir. 2014).
In addition to proving the loss, the plaintiffs are required to prove of the amount of
the loss. See Washington Mut., Inc. v. United States, 130 Fed. Cl. 653, 686-87 (2017)
(citing United States v. Janis, 428 U.S. 433, 440 (1976)) (“[P]laintiffs bear the burden to
prove, by a preponderance of the evidence, that they are entitled to the tax deductions at
issue in this case and the correct amount of the tax refund due.”), aff’d sub nom., WMI
25
Holdings Corp. v. United States, 891 F.3d 1016 (Fed. Cir. 2018). As indicated in
Washington Mutual, “plaintiffs will not recover in a tax refund case if they cannot prove
the amount of the refund due.” Id. at 687.
As noted above, regarding the Rochlises, the second amended complaint in Case
No. 16-200T alleges:
The Rochlises timely filed their protective claim on a 2009 1040X . . . to
report to the Derivium theft loss on July 22, 2013 under the three year
statute of limitations under I.R.C. § 6511(a). Once they received the expert
report from Moss Adams, they timely filed their 2009 1040X on September
9, 2014 to report their theft loss of $896,308. On their 2009 1040X the
Rochlises requested a tax refund of $4,873.
Regarding Irene M. Warren, the second amended complaint in Case No. 16-201T
alleges that:
The Estate of Irene M. Rochlis timely filed a protective claim on a 2009
1040X . . . to report to the Derivium theft loss on July 22, 2013 under the
three year statute of limitations under I.R.C. § 6511(a). Once the estate
received the expert report from Moss Adams, the Executor timely filed a
2009 1040X on September 9, 2014 to report theft loss of $75,672. The
Estate of Irene M. Rochlis requested a tax refund of $19,519.
Regarding the Ishiis, the amended complaint in Case No. 16-210T alleges, “[t]he
Ishiis timely filed their protective claim on a 2009 1040X . . . to report to the Derivium theft
loss on July 22, 2013 under the three year statute of limitations under I.R.C. § 6511(a),
and “[t]he Ishiis have satisfied the requirements of I.R.C. § 7422(a) because more than
six months have elapsed since said Claim for Refund was filed and said Claim has neither
been allowed nor disallowed by the Internal Revenue Service.”
Defendant argues that “[e]ven if plaintiffs could establish that something of value
was taken from them, the evidence presented at the trial of this case establishes that
plaintiffs are not entitled to any refund. First, no theft loss was sustained in 2009, the year
for which plaintiffs seek a refund.” By contrast, plaintiffs argue that “2009 is the correct
year for the theft-loss deduction because that is the first year Plaintiffs could meet their
burden of proof.”
As noted above, Treasury Regulation § 1.165-8(a)(1), states in part, “any loss
arising from theft is allowable as a deduction under section 165(a) for the taxable year in
which the loss is sustained,” and Treasury Regulation § 1.165-8(a)(2) provides that “[a]
loss arising from theft shall be treated under section 165(a) as sustained during the
taxable year in which the taxpayer discovers the loss,” and “[t]hus, a theft loss is not
deductible under section 165(a) for the taxable year in which the theft actually occurs
unless that is also the year in which the taxpayer discovers the loss.” Treas. Reg. § 1.165-
8(a). Pursuant to the Master Loan Agreements, the Rochlises transferred more than two
26
million dollars’ worth of securities to Derivium in February and May of 2000,25 Irene M.
Warren transferred approximately $200,000 of Cisco stock to Derivium on June 7, 2000,
and the Ishiis transferred more than two million dollars’ worth of securities to Derivium
between December 1999 and September 2000.26
As made clear from the joint stipulations and the testimony at trial, “the claim that
the 90% Loan Program involved ‘hedging’ is false or fraudulent. No funds were used to
hedge any 90% Loan transactions. Cathcart’s claim that the use of the 90% Loan
proceeds . . . constituted hedges against securities was pure fiction and constituted
nothing more than an economic gamble.” Moreover, as early as 2001, Derivium began
defaulting on its obligations to its clients “when the first transactions engaged in by
Derivium in 1998 began maturing,” and “Derivium defaulted because Derivium had no
genuine hedges in place, had no reserves, and the proceeds from new 90% Loan
transactions were insufficient to allow Derivium to purchase the replacement securities
on the open market for those customers who did seek a return of their highly appreciated
stocks.” Although any theft arising from the fraudulent transactions from 1999 or 2000
may have occurred in those years, the parties agree that the parties did not discover, or
could not have discovered, the fraud in 1999 or 2000.27
25 As indicated above, the Rochlises transferred the following securities to Derivium:
Stock Transfer Date Shares Value as Assigned by Derivium
AMZN As of February 23, 2000 2,000 $140,870.00
CSCO As of February 23, 2000 4,000 $554,500.00
CSCO As of May 23, 2000 15,000 $758,203.00
INTC As of May 23, 2000 1,200 $131,850.00
ISSX As of February 25, 2000 2,000 $198,250.00
MSFT As of May 23, 2000 1,500 $94,781.00
NTAP As of February 25, 2000 1,000 $205,438.00
Total Securities $2,083,892.00
26 As indicated above, the Ishiis transferred the following securities to Derivium:
Stock Transfer Date Shares Value as Assigned by Derivium
SWCM As of December 21, 1999 50,000 $4,800,000.00
SWCM As of January 10, 2000 28,000 $2,567,250.00
SWCM As of March 16, 2000 7,353 $944,861.00
SWCM As of September 20, 2000 11,024 $1,760,395.00
Total Securities $2,083,892.00
27 Defendant’s post-trial brief, citing the parties’ joint stipulations, states:
It is also stipulated that Derivium did not begin defaulting on its obligation to
replace customers until October 2001. Therefore, in 1999 and 2000, when
plaintiffs transferred their stocks to Derivium, it was not certain that Derivium
would not have replaced those stocks in 2002 and 2003, when the loan
terms ended, in the event plaintiffs sought a return of those stocks.
27
Plaintiffs argue that 2009 is the correct year to use, as
[p]laintiffs submit that until Cathcart's 2009 admissions it could not be
proven by preponderance of the evidence that Derivium had intent to steal
Plaintiffs’ actual collateral. True there was some evidence prior to 2009 that
Derivium stole others’ collateral and may even have stolen most collateral,
but intent is required for all definitions of theft. That specific intent to steal
Plaintiffs’ stocks could not have been proved without at least some evidence
going to Cathcart’s state of mind. Sufficient evidence to that effect did not
exist until his 2009 admissions.
(emphasis in original; internal reference omitted). At trial, it was apparent that the plaintiffs
did not have actual knowledge of the fraud in 2007, or even in 2009. Plaintiffs’ counsel
asked Mr. Rochlis, regarding the failure of Derivium to complete the transaction, “[w]hen
did you find out that they hadn't done the hedge?” and Mr. Rochlis responded that “[y]ou
and some other attorneys contacted me in late 2012, early 2013.” As Mr. Ishii testified at
trial, in response to the question, “[d]o you recall having any knowledge of any court
decisions that have been entered or judgments entered in any of the litigation against
Derivium prior to 2009 that - where the Court found that Derivium had committed fraud
with respect to the 90 percent loan transaction?” Mr. Ishii responded: “I do not believe I
ever - I ever heard those - those things, so no.” In response to the follow-up question,
“[s]o the first time you knew anything about it was either - was, what, late 2012?” Mr. Ishii
testified: “Yes. I believe that it was.”
Defendant argues that “[w]hile there is a question regarding which rule regarding
year of discovery should apply in this case, it is clear that under any of the various rules
of discovery enunciated by the courts, plaintiffs’ [sic] could have discovered the fact that
Mr. Cathcart falsely represented that Derivium would hedge their stocks, and did so with
fraudulent intent, well before 2009.” Specifically, defendant contends that
[t]he same facts that Mr. Cathcart stipulated to in 2009 had already been
set forth in the Government’s complaint in that action that was filed in 2007.
United States v. Cathcart, 2007 WL 3219375, ¶ 49, 50, 74 (N.D. Cal. 2007).
Therefore, plaintiffs could have discovered the facts indicating that Mr.
Cathcart had fraudulently misrepresented that he would hedge their stocks
no later than 2007.
As explained above, the court notes that the entire first joint stipulation of facts in
the above captioned cases, as well as many additional joint stipulations in the second
joint stipulation of facts submitted to this court stem from the admissions and stipulations
by Charles Cathcart in United States of America v. Charles Cathcart, et al., N.D. Cal.,
Case No. C-07-4762 (filed Nov. 19, 2009).
(internal citations omitted). As discussed above, none of the plaintiffs sought a return of
their stocks when the loan term ended.
28
The preamble to the first joint stipulation of facts filed in this court states: “The
parties to the above-entitled action, having met and conferred, and upon determining that
good cause exists, hereby stipulate to those facts that were stipulated by Charles
Cathcart and the Department of Justice in United States of America v. Charles Cathcart,
et al [sic], N.D. Cal., Case No: C-07-4762 PJH, document 398, filed 11/19/09.” (emphasis
in original). Rather than separately identify each joint stipulation for the above captioned
cases, the parties’ first joint stipulation states: “Charles Cathcart and the Department of
Justice stipulated to the facts contained in paragraphs 1-23, 25, 49-88, 90-93, 95-139,
141, 147-152, 155-157, 165-179, 183-191, and 193-196 of the United States of America’s
Proposed Findings of Fact and Conclusions of Law, document 348, attached as Exhibit
B.”
The preamble to the second joint stipulation of facts filed in this court similarly
states: “The parties to the above-entitled action, having met and conferred, and upon
determining that good cause exists, hereby stipulate to those facts that were stipulated
by Charles Cathcart and the Department of Justice in United States of America v. Charles
Cathcart, et al [sic], N.D. Cal., Case No: C-07-4762 PJH, document 398, filed 11/19/09.”
(emphasis in original). The second joint stipulation of facts also indicate that “Charles
Cathcart and the Department of Justice stipulated to the facts contained in paragraphs 1-
23, 25, 49-88, 90-93, 95-139, 141, 147-152, 155-157, 165-179, 183-191, and 193-196 of
the United States of America’s Proposed Findings of Fact and Conclusions of Law,
document 348.” Unlike the previous version of the joint stipulation of facts, in the second
joint stipulation of facts, the parties separately broke out each of the stipulations from the
previous case and created stipulations for the above captioned cases. By way of example,
the first two stipulations in the second joint stipulation of facts state:
1. Charles Cathcart (“Cathcart”) served as the “controlling mind” and “prime-
mover” of the 90% Loan scheme. [Findings of Fact ¶1]
2. Cathcart, a Ph.D. economist, developed the concept for the 90% stock
loan program (“90% Stock Program”) in 1997, and in the same year began
promoting a variety of 90% Loan products through FSC First Security
Capital (Texas), which he co-owned with several individuals, including
Kenneth Calvert (“Calvert”), David Kekich (“Kekich”), Rob Rawlings
(“Rawlings”), and Clifford Lloyd (“Lloyd”). [Findings of Fact ¶2][28]
The only unique stipulation in the above captioned cases is the final stipulation, number
132, which states: “Irene M. Rochlis (aka Warren) passed away on March 13, 2011. Jon
A. Rochlis, her son, was appointed as the Executor of her Estate.”
28 The court notes that the stipulations in the above captioned cases, even though
organized differently are identical to the United States of America’s Proposed Findings of
Fact and Conclusions of Law in United States of America v. Charles Cathcart, et al., N.D.
Cal., Case No: C-07-4762 PJH.
29
It is the admissions and stipulations by Charles Cathcart in United States of
America v. Charles Cathcart, et al., N.D. Cal., Case No: C-07-4762 (filed Nov. 19, 2009),
and not the allegations in the 2007 complaint that the parties in the above captioned cases
rely on in forming their own stipulations. As indicated above, the admissions and
stipulations in the case of United States of America v. Charles Cathcart, et al. were filed
on November 19, 2009. Moreover, plaintiffs argue that until the 2009 admissions by
Charles Cathcart, referenced in the introduction to both joint stipulations, “it could not be
proven by preponderance of the evidence that Derivium had intent to steal Plaintiffs’
actual collateral. True there was some evidence prior to 2009 that Derivium stole others'
collateral and may even have stolen most collateral, but intent is required for all definitions
of theft.” (emphasis in original). Plaintiffs further contend that it was “[t]hat specific intent
to steal Plaintiffs’ stocks could not have been proved without at least some evidence going
to Cathcart’s state of mind. Sufficient evidence to that effect did not exist until his 2009
admissions.”
Additionally, defendant argues that the standard for discovery of a theft loss is:
A theft loss is discovered when the taxpayer has knowledge both of a loss,
and that it was the result of a theft. Webber v. Commissioner, 1992 WL
335901 *4 (T. Ct. 1992). However, “discovery” does not require that there
be a judicial determination that a theft occurred. Rather, discovery occurs
“when a claimant learns of the facts giving rise to a cause of action, not
when a claimant learns that those facts present a violation of law.” McCune
v. U.S. Dept. of Justice, 592 F. Appx. 267 [sic], 291 (5th Cir. 2014).
Plaintiffs assert, however, that “[d]efendant discusses at length the discovery rule vis a
vis statutes of limitation for tort, RICO, Right to Financial Privacy Act, or securities fraud
claims, but not tax theft loss.” (emphasis in original). In a footnote to its post-trial brief:
Defendant acknowledges that McCune[29] and several of the other cases
discussed in this part involve analysis of a “discovery rule” that relates to
determination of when a cause of action arises for purposes of the statute
of limitations for bringing suit against the alleged perpetrator of a fraud or
theft. We believe, however, that the principles discussed in those cases
apply at least by analogy to the circumstances of these cases.
Defendant, therefore, admits that cases cited by defendant in its post-trail brief for the
“discovery rule” and the argument that discovery occurs “‘when a claimant learns of the
facts giving rise to a cause of action, not when a claimant learns that those facts present
a violation of law,’” (quoting McCune v. U.S. Dep’t of Justice, 592 F. App’x at 291), have
29
The court notes that McCune v. U.S. Department of Justice, is an unpublished decision
from the United States Court of Appeals for the Fifth Circuit. See McCune v. U.S. Dep’t
of Justice, 592 F. App’x 287 (5th Cir. 2014). In addition, McCune involves violations for
the Right to Financial Privacy Act, and the corresponding three year statute of limitations,
and not theft loss. See id. at 288.
30
not been applied to cases involving theft loss. Notably, the only theft loss case cited by
the defendant is Webber v. Commissioner, albeit a Tax Court case,30 and not a United
States Court of Federal Claims case.
The Webber decision cited by defendant indicates that “it is the discovery of the
theft, and not a mere claim to one of the other losses enumerated under section 165, that
entitles petitioner to the theft loss deduction. ‘Until knowledge of both theft and loss
coexist, a theft loss deduction is untenable.’” Webber v. Comm’r, T.C.M. 1992-667, 1992
WL 335901, at *4 (Nov. 18, 1992) (quoting Marine v. Comm’r, 92 T.C. 958, 976 (1989),
aff’d, 921 F.2d 280 (9th Cir. 1991) (emphasis in original). This is consistent with other Tax
Court decisions. See, e.g., Bunch v. Comm’r, T.C.M. 2014-177, 2014 WL 4251136, at *6;
Allen v. Comm’r, 16 T.C. 166. 31
Defendant also cites to two decisions related to the Derivium fraud as at issue in
the cases currently before this court that defendant argues prove the plaintiffs knew or
should have known about the fraud prior to 2009, Raifman v. Wells Fargo Advisors, LLC
and Landow v. Wachovia Securities, LLC. Defendant claims that regarding the decision
in Raifman:
Raifman v. Wells Fargo Advisors, LLC, 2014 WL 120134436 [sic] (N.D.
Calif. 2014), was a securities fraud action brought by five Derivium investors
against the successor to Wachovia, the broker that sold the stocks for
Derivium. The basis for the suit was the contention that Derivium committed
fraud and that Wachovia was complicit in that fraud. The District Court
dismissed the case because it concluded that the Derivium investors could
have discovered the fraudulent conduct of Mr. Cathcart by no later than
2006.
The court notes that Raifman v. Wells Fargo Advisors, LLC, Case No. C 11-02885
SBA, 2014 WL 12013436 (N.D. Calif. March 31, 2014), is an unreported decision from
the United States District Court for the Northern District of California. The Raifman court
30 Although many of decided cases involving the issue of theft loss in tax cases emanate
from the United States Tax Court, Tax Court decisions are not binding on the United
States Court of Federal Claims. See Arbitrage Trading, LLC v. United States, 108 Fed.
Cl. 588, 602 n.23 (2013) (quoting Hinck v. United States, 446 F.3d 1307, 1314 (Fed. Cir.
2006), aff’d, 550 U.S. 501 (2007) (The court acknowledges, however, that “[a]lthough
decisions of the Tax Court are not binding on this court, the Tax Court ‘is a specialized
court with expertise in tax matters.’”)).
31 As indicated above, the taxpayer is not required to demonstrate a conviction has
occurred to be able to recover a tax theft loss, nor does a taxpayer have to wait until a
criminal conviction to seek a refund. See Vietzke v. Comm’r, 37 T.C. 510. As noted
above, the United States Court of Appeals for the Federal Circuit has held that for theft
losses under 26 U.S.C. § 165, the “appropriate burden is proof by a preponderance of the
evidence.” See Krahmer v. United States, 810 F.2d at 1147.
31
in its factual findings pointed out that “[i]n December 2004, Wachovia closed all of
Derivium’s brokerage accounts and ceased any further account activities. On September
1, 2005, Derivium filed for bankruptcy protection. In October 2005, Forbes published an
article, titled ‘Offshore Mystery,’ which described Derivium's 90% Stock-Loan Program
and reported that the program was referred to as a ‘Ponzi scheme.’” Id. at *2 (internal
references omitted). The plaintiffs in Raifman alleged that they were “fraudulently induced
by Wachovia to enter into their respective Master Agreements and Wachovia Account
Agreements between 2000 and 2004.” Id. The Raifman court considered whether Virginia
law or California law should apply for the negligence and fraud claims against Wachovia,
but ultimately determined that “because Plaintiffs’ claims are untimely under California
and Virginia law, the Court will not decide the choice of law issue. As discussed below,
even under California’s more generous rules, Plaintiffs’ claims are time-barred.” Id. at *7.
In reaching that conclusion, although specific to the Raifman plaintiffs, the
Raifman, the court discussed the facts of the Derivium theft, as follows:
Based on Wachovia’s involvement in the 90% Stock-Loan Program as
alleged in the TAC [third amended complaint], the Court finds that the
Raifmans had reason to suspect wrongdoing regarding the program in late
2006, and therefore had an affirmative obligation to discover the facts
supporting their claims against Wachovia and to file a complaint within the
applicable limitations period. By late 2006, sufficient indicia of fraud existed
to place the Raifmans on inquiry notice that they had been harmed by the
90% Stock-Loan Program. Once the Raifmans’ collateral for their first stock-
loan was not returned, they had a reasonable basis to question the validity
of the representations made by Derivium and Wachovia concerning the
90% Stock-Loan Program. At that time, they had reason to suspect at least
one fraudulent act; namely, that the ValueClick stock they pledged as
collateral for their first stock loan was immediately sold by Wachovia, not
hedged, without their permission purportedly in violation of their Wachovia
Account Agreement and their Master Agreement. See Brandon G. [v. Gray],
111 Cal. App. 4th [29,] 35 [(2003)] (A plaintiff is on inquiry notice of its fraud
claims when he “learns, or at least is put on notice, that a representation [is]
false.”). When the Raifmans had a suspicion of wrongdoing in late 2006,
they were required to conduct a reasonable investigation of all potential
causes of their injury.
Raifman v. Wells Fargo Advisors, LLC, 2014 WL 12013436, at *9 (footnotes omitted).
The Raifman court continued:
The TAC does not allege specific facts showing that, despite diligent
investigation of the circumstances of their injury, the Raifmans could not
have reasonably discovered facts supporting their claims against Wachovia
within the applicable limitations periods. While the TAC alleges that the
Raifmans could not have learned of Wachovia’s wrongdoing in connection
with the 90% Stock-Loan Program until Plaintiffs’ counsel discovered the
32
Cathcart Letter in late 2010, it is silent regarding the Raifmans’ investigation
into the causes of their injury. Plaintiffs provide no explanation for why the
TAC omits the facts discussed above regarding the Raifmans’ investigation
into the 90% Stock-Loan Program in late 2006.
Id. (footnote omitted).The Raifman court concluded that the plaintiff’s claims against
Wachovia were time-barred. See id. at *13.
Defendant in the cases currently before the court, further cites to a 2013 decision
issued by the United States District Court for the Eastern District of New York also
involving the Derivium fraud. Defendant states in its post-trial brief:
Landow v. Wachovia Securities, LLC, 966 F. Supp. 2d 106 (E.D. N.Y. 2013),
was another securities fraud action brought against Wachovia, based on
the same allegations of fraud at issue in Raifman. After setting forth an
extensive listing of the numerous fraud actions instituted against Mr.
Cathcart between 2003 and 2007, the District Court concluded that Mr.
Landow could have discovered the facts establishing that Mr. Cathcart
committed fraud by no later than 2007. 966 F.Sujpp.2d [sic] at 120-23, 128.
It is clear that plaintiffs could have discovered the fraudulent conduct of Mr.
Cathcart prior to 2009.
In Landow v. Wachovia Securities, LLC, 966 F. Supp. 2d 106, which case is also
specific to the Landow plaintiff in the same way as the Raifman case was, but which also
included a discussion of the Derivium history, the defendant indicated, the court identified
a series of events and dates for the Derivium fraud including:
(1) On April 9, 2003, a borrower under the 90% Loan Program commenced
an action against, inter alia, Derivium and Wachovia in the United States
District Court for the District of Connecticut, asserting, inter alia, a claim for
breach of fiduciary duty against Wachovia. McCarty v. Derivium Capital,
LLC, No. 3:03 CV 00651 MRK (D. Conn.).
(2) In 2004, General Holding Inc. (“General Holding”) commenced an action
against, inter alia, Bancroft, the Derivium owners, Derivium, Veridia and
Optech in the United States District Court for the District of California,
Sacramento Division, asserting claims, inter alia, for fraud, conversion and
violations of the Racketeer Influenced Corrupt Organizations Act, 18 U.S.C.
§ 1962(a). General Holding Inc. v. Cathcart, No. 2:04–2749–DFL–DAD (D.
Calif.).
(3) On May 3, 2005, Newton Family LLC (“Newton Family”) commenced an
action against, inter alia, Derivium, Bancroft, the Derivium owners and
Veridia, asserting claims, inter alia, for fraud, constructive fraud, RICO
violations, conversion and federal securities fraud. Newton Family LLC v.
Cathcart, No. 2:07–cv–2964–DCN (D.S.C.).
33
(4) In September 2005, Derivium filed for Chapter 11 bankruptcy in the
United States Bankruptcy Court for the Southern District of New York. In re
Derivium Capital, LLC, No. 05–37491 (Bankr. S.D.N.Y.).
(5) On October 17, 2005, Forbes.Com published an article about Derivium's
90% Loan Program, referring to it as “a very sophisticated Ponzi scheme;”
indicating, inter alia, that “Derivium * * *, is in bankruptcy and under
investigation by the Internal Revenue Service” and that Cathcart had said
in a deposition the previous year that “he controlled the risk of a slide in the
stock price by immediately selling the stock * * * [and] had no ‘specific
knowledge’ of what hedges actually took place[;]” and referencing five (5)
arbitrations and/or suits that had already been brought against Derivium by
investors in the 90% Loan Program. Janet Novack, Offshore Mystery, (Oct.
17, 2005), at http://www.forbes.com/forbes/2005/1017/058_print.html.
(Picon Decl., Ex. C).
(6) On November 3, 2005, WCN/GAN Partners Ltd. (“WCN/GAN”)
commenced an action against the Derivium owners and Bancroft asserting
claims, inter alia, for fraud, constructive fraud, RICO violations, conversion
and federal securities fraud. WCN/GAN Partners Ltd. v. Cathcart, No. 2:07–
cv–2965–DCN (D.S.C.).
Landow v. Wachovia Sec., LLC, 966 F. Supp. 2d at 120-21 (emphasis, alterations, and
omission in original). The Landow court issued 31 findings of fact, some of which are
unrelated to the above captioned cases, but which included:
(20) On September 17, 2007, the United States commenced an action
against, inter alia, Derivium, Veridia and the Derivium owners in the United
States District Court for the Northern District of California to enjoin the
promotion of the 90% Loan Program as a tax-fraud scheme (“the California
Cathcart case”). United States v. Cathcart, No. C 07–04762 PJH (N.D.
Calif.)[.]
(21) In October 2007, a published decision was entered in the bankruptcy
proceeding. In re Derivium Capital, LLC, 380 B.R. 392 (Bankr. D.S.C. 2007)
(denying Campbell's application for Sale of Property Free and Clear of Lien
and Settlement of Claims in Connection Therewith).
(22) On December 21, 2007, borrowers under the 90% Loan Program
commenced an action in the United States District Court for the Northern
District of California challenging the IRS’s treatment of a loan into which
they entered under the 90% Loan Program in 2000 as a sale of stock.
Schlachte v. United States, No. C 07–6446 PJH (N.D. Calif.)[.]
Landow v. Wachovia Sec., LLC, 966 F. Supp. 2d at 122-23.
34
The Landow plaintiff’s causes of actions were against Wachovia, accusing
Wachovia, among other things of agreeing “with Derivium to commit fraud against him
and other borrowers under the 90% Loan Program,” as well as accusing Wachovia of
acting in concert with Derivium to knowingly draft false loan documents, Wachovia being
aware Derivium was making false representations to Mr. Landow, and Wachovia
breaching its fiduciary duty to Mr. Landow. See id. at 117-18. The Landow court applied
New York law, as the Landow plaintiff was a New York State resident and noted that “New
York law provides that an action based upon fraud, including claims of aiding and abetting
and conspiracy to commit fraud, must be commenced within ‘the greater of six years from
the date the cause of action accrued or two years from the time the plaintiff * * * discovered
the fraud, or could with reasonable diligence have discovered it.’” Id. at 126 (quoting N.Y.
C.P.L.R. § 213(8)). The Landow court also determined, regarding Mr. Landow’s claims
for breach of fiduciary duty, that “[c]laims for breach of fiduciary duty, and aiding and
abetting breach of fiduciary duty, that are based upon fraud are subject to the same
limitations period, i.e., six (6) years from the date the cause of action accrued or two (2)
years from the time the plaintiff discovered, or could with reasonable diligence have
discovered, the fraud.” Id.
The Landow court stated that “[o]n or about April 9, 2003, plaintiff entered into six
(6) loans with Derivium and Bancroft under the 90% Loan Program. The terms of those
loans ranged from twenty-seven (27) to thirty-eight (38) years,” and 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.” Id. at 114
(internal references omitted). The Landow court noted:
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,” and
according to the Landow plaintiff, the authorization to transfer his FRNs into
Bancroft's Wachovia account did not authorize Wachovia to sell those
securities, 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. at 115 (internal references omitted). The Landow court determined,
it is undisputed that those claims accrued no later than April 21, 2003, when
the transfer occurred. Since this action was not commenced until June 29,
2012, more than nine (9) years after the fraud occurred, plaintiff's fraud-
based claims, including his fraud-based breach of fiduciary duty and aiding
and abetting breach of fiduciary claims, are timely only if they were
commenced within two (2) years of the date plaintiff discovered the fraud,
or could have discovered the fraud in the exercise of reasonable diligence.
Id. at 126-27. The Landow court reasoned:
35
The question, thus, is whether plaintiff could reasonably have inferred any
of defendants’ fraud from the facts known to him, or that were publicly
asserted and reasonably accessible upon diligent inquiry. Assuming the
truth of plaintiff’s allegation that Wachovia continued to send him quarterly
account statements falsely representing to him that his FRNs [Floating Rate
Notes] were still being held as collateral under the loans, such quarterly
statements ended as of August 2005. Accordingly, defendants’ purported
concealment of the fraud ended as of August 2005, almost seven (7) years
prior to the commencement of this action. Nonetheless, it cannot be
ascertained based upon the pleadings and documents integral thereto, or
upon the matters of which judicial notice may be taken, whether plaintiff was
placed on inquiry notice of defendants’ purported fraud as of August 2005,
when the quarterly statements stopped.
However, it is clear that plaintiff had knowledge of at least one fraudulent
act, i.e., that his FRNs had been sold, and, thus, were no longer being held
as collateral, no later than July 2007, when he received notice from the IRS
that he owed taxes, penalties and interest based upon the sale of those
FRNs. It is the very sale of the FRNs immediately upon their transfer from
plaintiff’s Wachovia account to the Wachovia account held by Bancroft,
purportedly prior to the commencement of the respective loan terms, upon
which plaintiff premises most of his fraud-based claims against defendants.
The sale of a borrower’s collateral immediately upon the transfer of such
collateral from the borrower’s brokerage account at Wachovia to another
Wachovia account, purportedly in direct contravention of the loan terms and
the representations previously made to the borrower, would suggest the
probability of fraud, and defendants’ participation therein, to a reasonably
intelligent borrower. Thus, plaintiff clearly had knowledge of facts from
which the alleged fraud by defendants might reasonably be inferred as of
2007, prompting a duty to inquire under New York law.
Landow v. Wachovia Sec., LLC, 966 F. Supp. 2d at 128 (internal reference omitted).
Based on the above, the Landow court reasoned that the plaintiff “clearly had
knowledge of facts” that fraud might have been committed. See id. The same facts are
not present in the above captioned cases as the current plaintiffs may have been unaware
of issues with the hedging, as they surrendered their stock when the loan was complete,
and appear not to have received any notices from the IRS like those received by Mr.
Landow. Mr. Rochlis testified at trial that he signed the various documents selecting the
option “I/we hereby officially surrender my/our collateral in satisfaction of my/our entire
debt obligation.”32 Mr. Ishii did the same, and as discussed, during the cross-examination
at trial, defendant’s counsel asked, “because the stock was worth a tiny fraction of what
32At trial, Mr. Rochlis also offered “I will point out that I didn’t voluntarily surrender it, as
you maintain, because they had already stolen it. I mean, you can’t surrender something
that someone stole under false pretenses.”
36
the loan - the principal and interest due on the loan was, you elected to surrender your
stock and walk away from the deal?” to which Mr. Ishii responded: “Yeah, I elected to - to
surrender the collateral.” In response to the question, “as a result of surrendering the
collateral and walking away from the loan, you were not required to make any payment
to Derivium at the end of the transaction,” Mr. Ishii responded: “Correct.”33
Unlike the plaintiffs in Landow and Raifman, the above captioned plaintiffs appear
to have been unaware of any potential theft of their securities, given that they did not seek
to have their securities returned to them at the end of the loan period. The plaintiffs’
knowledge prior to 2009 was not established as it was for the other victims of the fraud
for whom Derivium did not return their collateral or for victims for whom Derivium stopped
providing financial statements. Those plaintiffs would have had clear knowledge of
possible fraud. Jon A. Rochlis testified that “Derivium never told us that they had
assigned, pledged, sold, or anything to the collateral. They gave us statements every
quarter for the duration showing how many shares they were holding for us. In fact, those
were adjusted for splits. They showed dividends.” As reflected in the findings of fact,
plaintiffs in the above captioned cases, chose to surrender their securities as they were
worth less than the loan value. Plaintiffs never sought to recover their stocks, continued
to receive statements, and, apparently, were unaware during the loan period that
Derivium was perpetrating a fraud. As noted above, Mr. Rochlis, and likely his mother,
Ms. Warren, based on Mr. Rochlis role as facilitating the transaction for his mother and
advising her, appear not to have had actual knowledge of the fraud until 2009 at the
earliest based on the record before the court. Plaintiffs’ counsel asked Mr. Rochlis,
regarding the failure of Derivium to complete the transaction, “[w]hen did you find out that
they hadn’t done the hedge?” and Mr. Rochlis responded that “[y]ou and some other
attorneys contacted me in late 2012, early 2013.” Similarly, Mr. Ishii testified at trial, in
response to the question, “[d]o you recall having any knowledge of any court decisions
that have been entered or judgments entered in any of the litigation against Derivium prior
to 2009 that - where the Court found that Derivium had committed fraud with respect to
the 90 percent loan transaction?” Mr. Ishii responded: I do not believe I ever - I ever heard
those - those things, so no.” Additionally, although the Landow and Raifman cases are
based on the same Derivium fraud, the posture of those cases was different from the
above captioned cases. The Landow and Raifman cases were fraud cases against
Wachovia, and, as such, had different statute of limitations issues, not present in the
above captioned cases. Indeed, plaintiffs argue that “this is not a statute of limitations
issue and those principles do not apply. The issue here is not when a statute of limitations
starts to run. Rather it is definition of word ‘discovery’ in the statute. I.R.C. § 165(e).”
As indicated above, the Treasury Regulations for theft loss provide that a plaintiff
is not entitled to a theft loss deduction until the plaintiff cannot demonstrate with
reasonable certainty if a possibility of recovery exists. See Treasury Regulation § 1.165–
1(d)(3); see also Adkins v. United States, 113 Fed. Cl. at 807. Plaintiffs allege that there
was no possibility of recovery for any alleged theft. Plaintiffs note that “[o]n September 1,
2005, Derivium Capital, LLC filed Chapter 7 in United States Bankruptcy Court, District of
33As noted above, Ms. Warren did not testify at trial, but the record reflects that she
surrendered her stock, like Mr. Rochlis and Mr. Ishii.
37
South Carolina (Charleston), Bankruptcy Petition #: 05-1 5042,” but that plaintiffs did not
participate in the bankruptcy case. The plaintiffs also speculate that “[b]ased on the
Trustees Final Report in Case No. #: 05-15042, Dkt 1003, filed on 12/27/2017, if they had
participated they would not have received anything from the bankruptcy process.” The
defendant does not challenge that there was no prospect of recovery for the plaintiffs in
the above captioned cases. Therefore, given the requirement established by the United
States Court of Appeals for the Federal Circuit that plaintiffs must prove a theft loss by a
preponderance of the evidence, see Krahmer v. United States, 810 F.2d at 1147, when
combined with the Treasury Regulations requirement that a theft loss deduction requires
the loss be knowable, and, that there was no reasonable prospect of recovery, on the part
of the indiviuals claiming the loss, see 26 C.F.R. § 1.165–1(d)(2)(i), and, that in the above
captioned cases, the fact that requisite intent was not established until Charles Cathcart’s
2009 admissions, the court determines that plaintiffs may use 2009 as a date for a theft
to have occurred, assuming a theft took place. See Jeppsen v. Comm’r, 128 F.3d at 1418;
Adkins v. United States, 113 Fed. Cl. at 807.
The parties disagree as to what law should be applied to an alleged theft in the
above captioned cases for a 2009 potential theft. The court notes that plaintiffs initially
argue that the court should not apply state law at all, and argue that “[t]he meaning of
theft cannot depend on the vagaries of state law.” 34 For their argument that state law
should not govern, plaintiffs cite to only a single United States Court of Federal Claims
decision, Goeller v. United States, 109 Fed. Cl. 534. In Goeller, Judge Allegra took issue
with the deference courts give to the approach taken by the United States Court of
Appeals for the Fifth Circuit in the decision in Edwards v. Bromberg, cited above, which
determined that
[u]nder this line of decisions it has been long and well established that
whether a loss from theft occurs within the purview of Section 23(e)(3) of
the Internal Revenue Code of 1939 and the corresponding provisions of
prior acts, depends upon the law of the jurisdiction where it was sustained
and that the exact nature of the crime, whether larceny or embezzlement,
of obtaining money under false pretenses, swindling or other wrongful
deprivations of the property of another, is of little importance so long as it
amounts to theft.
Edwards v. Bromberg, 232 F.2d at 111. In Goeller, Judge Allegra wrote:
Neither Edwards nor any of its progeny, however, explain why state law
should control the definition of what is a “theft”-most opinions are satisfied
to treat the sentence from Edwards quoted above as axiomatic. As such,
none of them begin to explain why Congress would want state-by-state
34 The court notes that although plaintiffs argue that “[t]he meaning of theft cannot depend
on the vagaries of state law,” in arguing that 2009 was the operative year, plaintiffs cite
to Bunch v. Commissioner, which plainly states: “Whether a theft loss has been
established depends upon the law of the State where the alleged theft occurred.” Bunch
v. Comm’r, 2014 WL 4251136, at *6.
38
variability in the treatment of theft losses for Federal income tax purposes,
particularly via a provision in which all the other triggering events for
deductible losses-fire, storm, shipwreck, or casualty-are defined not by
state law, but by reference to their plain meanings.
While the court is hesitant to replow a field that has been so extensively
cultivated, it is obliged to do so, as none of the precedents adopting state
law are binding here. Try as it might, the court cannot resist concluding that
the idea that section 165(c)(3) somehow incorporates state criminal law into
what is otherwise a federal taxing statute is a non sequitur. On close
examination, the contrary view—that state law is controlling—appears to be
a shibboleth that, by constant repetition, has become embedded in the
jurisprudence of section 165. And “as is generally true of legal fictions, there
are hosts of problems with this often-reiterated, but little analyzed,
proposition.” See Barnes v. United States, 68 Fed. Cl. 492, 501 (2005).
Goeller v. United States, 109 Fed. Cl. at 540 (emphasis in original). Judge Allegra,
therefore, looked to the common law definition of theft to achieve a uniform, workable
definition of theft for the Tax Code, as well as to Federal law and how the Federal law
views theft in other contexts. Judge Allegra also noted the definition of theft under the
Model Penal Code and how Black’s Law Dictionary defined the term. Judge Allegra noted:
The key word in the statute-“theft”-has a long-standing and well-accepted
meaning. Familiar lexicons mark this path. Thus, Black's Law Dictionary
defines that term as “[t]he fraudulent taking of corporeal personal property
belonging to another, from his possession, or from the possession of some
person holding the same for him, without his consent, with intent to deprive
the owner of the value of the same, and to appropriate it to the use or benefit
of the person taking.” Black’s Law Dictionary 1647–48 (4th ed. 1951); see
also Webster's New Int’l Dictionary 2618 (2d ed. 1948) (theft: “the felonious
taking and removing of personal property, with intent to deprive the rightful
owner of it”). At least by the time the 1954 Code was enacted, it also was
well-accepted that the definition of “theft” includes a crime in which one
“obtains possession of property by lawful means and thereafter
appropriates the property to the taker’s own use.” Black’s Law Dictionary
1648 (4th ed. 1951); see also Webster’s New Int’l Dictionary 2618 (2d ed.
1948) (theft includes “misappropriation or wrongful use of personal property
originally lawfully taken or received”). Definitions like these have formed the
ratio dicendi in many cases. These definitions of “theft” are largely
indistinguishable from that employed in the Model Penal Code, which
defines a “theft” as occurring where a person “unlawfully takes, or exercises
unlawful control over, movable property of another with purpose to deprive
him thereof.” Model Penal Code § 223.2(1); see also id. at § 223.3 (theft by
deception). This is relevant because the Model Code's provisions have
often been employed in determining the scope of an offense referenced in
a Federal statute. See, e.g., Taylor v. United States, 495 U.S. 575, 580, 598
39
n.8, 110 S. Ct. 2143, 109 L. Ed. 2d 607 (1990); Hernandez–Mancilla v. INS,
246 F.3d 1002, 1007 (7th Cir. 2001).
These well-accepted definitions of “theft” make reference here to state law
unnecessary. Indeed, in determining whether particular conduct amounts to
“theft” under other Federal statutes, the Supreme Court has eschewed
applying an individual state’s laws in favor of embracing a more uniform,
common-law definition.
Goeller v. United States, 109 Fed. Cl. at 542-43 (emphasis in original) (footnote omitted).
Judge Allegra instead fashioned a definition for theft pursuant to 26 U.S.C. § 165(c) that
meant
the fraudulent taking of property belonging to another, from his possession,
or from the possession of some person holding the same for him, without
his consent, with the intent to deprive the owner of the value of the same,
and to appropriate it to the use or benefit of the person taking. This term
also includes one who obtains possession of property by lawful means and
thereafter appropriates the property.
Goeller v. United States, 109 Fed. Cl. at 549-50 (citations omitted). Judge Allegra applied
his analysis to determine that there were genuine issues of material fact and the issue of
a theft loss under 26 U.S.C. § 165 could not be decided on summary judgment. See
Goeller v. United States, 109 Fed. Cl. at 550.
Plaintiffs, citing to Judge Allegra’s decision in Goeller, argue that “Rochlis and
Warren were victims of theft under Goeller,” and also that “[t]he Ishiis were victims of theft
under Goeller.” As noted above, and as highlighted by defendant in response to plaintiffs’
argument, “it is well established that state law should be used to determine whether a
theft occurred.”35 Neither the parties, nor the court has identified a case issued by the
United States Supreme Court or the United States Court of Appeals for the Federal Circuit
as to which state law to apply to a theft loss. The decision in Edwards v. Bromberg is
supported by several decisions by other federal courts of appeals affirming cases which
applied a test of looking to the state law where the theft occurred. See, e.g., Lombard
Brothers, Inc. v. United States, 893 F.2d 520, 523 (2d Cir. 1990) (“For purposes of Section
165, ‘theft’ includes larceny, embezzlement, and robbery, see 26 C.F.R. § 1.165–8(d), as
defined by the law of the state where the claimed loss occurred-in the instant matter,
Connecticut. . . .”); Bellis v. Comm’r, 540 F.2d 448, 449 (9th Cir. 1976) (“It is fundamental
that the law of the Jurisdiction where the loss is sustained determines whether a theft has
occurred for purposes of Section 165(e).”); Howard v. United States, 497 F.2d 1270 (7th
Cir. 1974) (“It is impossible under this record to make any finding based upon credible
evidence that a theft occurred as defined by the Illinois statutes. . . .”). Likewise, a number
35Defendant also argues that even using the definition fashioned by Judge Allegra in
Goeller, “there would be no theft because no property belonging to plaintiffs was taken
and there was no specific intent to deprive plaintiffs of any property they owned.”
40
of United States Tax Court decisions have looked to the state law where the theft took
place for purposes of determining whether a theft loss deduction was appropriate
because a theft occurred. See, e.g., De Fusco v. Comm’r, 38 T.C.M. at 922 (“The question
whether a ‘theft’ occurred is, of course, determined by the law of the state where the loss
was sustained.”); see also Luman v. Comm’r, 79 T.C. 846, 860 (1982); Paine v. Comm’r,
63 T.C. 740; Hope v. Comm’r, 55 T.C. 1020, 1033-34 (1971) (applying Pennsylvania
law to determine whether a theft occurred for the purposes of a theft loss deduction) (citing
Edwards v. Bromberg, 232 F.2d at 111), aff’d, 471 F.2d 738 (3d Cir.), cert. denied, 414
U.S. 824 (1973); Herrington v. Comm’r, No. 12204-04, 2011 WL 1235720, at *4 (T.C.
Mar. 30, 2011) (“Generally, whether a theft loss has been sustained depends upon the
law of the State where the loss was sustained.”). Moreover, the IRS’ Revenue Rulings
have noted the state law test articulated in Edwards v. Bromberg. See Rev. Rul. 77-17,
1977-1 C.B. 44 (1977) (noting that the Fifth Circuit in Edwards v. Bromberg had “stated
that whether a loss from theft occurred depends upon the law of the jurisdiction where it
was sustained”). The court notes that the United States Court of Appeals for the Sixth
Circuit in United States v. Elsass, 769 F.3d 390, in declining to apply the Goeller standard,
noted that “at no point do defendants appear to have brought to the district court’s
attention any distinction between state-law and federal-common-law definitions of theft.”
Id. at 397.
In the above captioned cases, the plaintiffs merely cite to Judge Allegra’s case and
assert that state law should not apply. Despite Judge Allegra’s attempt to break new
ground in order to try and simplify and make more predictable the law by fashioning a
uniform definition of theft to apply to the United States Tax Code36 for situations such as
the ones presented here, this court will follow the lead of the numerous United States
Courts of Appeals and the United States Tax Court and will apply the relevant state law
in determining if a theft has occurred.37
36 The court recognizes Judge Allegra’s concern that because different state law could
apply to different plaintiffs, even based on the identical underlying facts of how a theft
occurred, the outcome could be different for individual plaintiffs. Absent legislative
direction or a precedential decision, the court is reluctant to adopt Judge Allegra’s
approach given the much more widespread existing consensus regarding the state law
approach articulated in Edwards v. Bromberg. The court also notes that a number of
interests in this court are defined by state law, including, for example, certain other
property determinations also within this court’s jurisdiction. As indicated by the United
States Supreme Court: “[W]e are mindful of the basic axiom that ‘“[p]roperty interests . . .
are not created by the Constitution. Rather, they are created and their dimensions are
defined by existing rules or understandings that stem from an independent source such
as state law.”’” Ruckelshaus v. Monsanto Co., 467 U.S. 986, 1001 (1984) (quoting Webb's
Fabulous Pharmacies, Inc. v. Beckwith, 449 U.S. 155, 161 (1980) (quoting Board of
Regents v. Roth, 408 U.S. 564, 577 (1972)))) (omission in original).
37The court notes that in addition to only citing to Judge Allegra’s decision, the plaintiffs
did not address why federal common law could apply in lieu of state law, or if the Model
Penal Code might apply to their refund claims. Notably, the Model Penal Code at section
223.2 does not refer to location when defining a theft:
41
In the event that state law is found to apply, “[d]efendant submits that
Massachusetts law controls the determination of whether Mr. Rochlis and Mr. Ishii
sustained theft losses, and Connecticut controls the determination of whether Irene
Rochlis sustained a theft loss.” By contrast, plaintiffs argue “[i]f the Court does not follow
Goeller, the Court should apply South Carolina law.”38 Plaintiffs argue that “[i]n this case,
South Carolina has general jurisdiction over the criminal actions of both Cathcart and
Derivium because Cathcart and Derivium reside in South Carolina and because the
activities at issue in this case occurred in South Carolina.” Plaintiffs argue:
The jurisdiction of State Courts is “subject to review for compatibility with
the Fourteenth Amendment’s Due Process Clause. [sic] Goodyear Dunlop
Tires Operations, S. A. [sic] v. Brown, 564 U.S. 915,918 (2011). A State
Court has court [sic] has general jurisdiction when the “paradigm forum” is
an “individual’s domicile,” or, for corporations, “an equivalent place, one in
which the corporation is fairly regarded as at home.” Id. at 924. In this case,
South Carolina has general jurisdiction over the criminal actions of both
Cathcart and Derivium because Cathcart and Derivium reside in South
Carolina and because the activities at issue in this case occurred in South
Carolina.
The court notes that in their supplemental post-trial briefs plaintiffs are more careful about
which law to apply, stating: “The issue of what state law applies is not simple. Plaintiffs
believe that several state laws could apply and that, if a preponderance of the evidence
shows that a theft occurred under any of the state laws, they should be entitled to a theft-
loss deduction.” Plaintiffs also concede that “Massachusetts and Connecticut law apply
because the losses were sustained in those states,” and indicate that “[c]ourts have held
that theft-loss claims are governed by the laws of the state where the loss was
‘sustained.’” Plaintiffs further state “[i]f that is the rule, then Plaintiffs believe that their
resident state is most likely were [sic] their losses were sustained: Massachusetts for Mr.
(1) Movable Property. A person is guilty of theft if he unlawfully takes, or
exercises unlawful control over, movable property of another with purpose
to deprive him thereof.
(2) Immovable Property. A person is guilty of theft if he unlawfully transfers
immovable property of another or any interest therein with purpose to
benefit himself or another not entitled thereto.
Model Penal Code § 223.2 (2019) (emphasis in original).
38 The plaintiffs’ briefs also state: “Alternatively, Rochlis and Warren, were also victims of
theft under Massachusetts law,” and “the Ishiis, were also victims of theft under
Massachusetts law.” The plaintiffs’ briefs further state: “Alternatively, Irene Warren was a
victim of theft under Connecticut law,” because “Irene Warren was a resident of
Connecticut when the theft occurred.”
42
Rochlis and Mr. Ishii, Connecticut for Mrs. Warren.” (footnote omitted). As noted above,
the court applies the relevant state law in determining if a theft has occurred. See
Lombard Brothers, Inc. v. United States, 893 F.2d at 523; Bellis v. Comm’r, 540 F.2d 448;
Howard v. United States, 497 F.2d 1270; Edwards v. Bromberg, 232 F.2d at 111. The
court will apply Massachusetts law for the claims of the Rochlises and Ishiis, as they
resided in Massachusetts when the Derivium transactions were entered into, and
therefore, the alleged theft of the value of their stock took place,39 and Connecticut law
for Irene M. Warren for the same reasons. Kenneth Ishii resided in Massachusetts during
1999 and 2000 when his Derivium transactions took place. Jon A. Rochlis resided in
Massachusetts during 2000 when his Derivium transactions took place. The definition of
theft under Massachusetts state law is:
Whoever steals, or with intent to defraud obtains by a false pretence, or
whoever unlawfully, and with intent to steal or embezzle, converts, or
secretes with intent to convert, the property of another as defined in this
section, whether such property is or is not in his possession at the time of
such conversion or secreting, shall be guilty of larceny. . . .
Mass. Gen. Laws 266 § 30(1) (1999).40 Property, under Massachusetts state law, is
defined for theft as
The term “property,” as used in this section, shall include money, personal
chattels, a bank note, bond, promissory note, bill of exchange or other bill,
order or certificate, a book of accounts for or concerning money or goods
due or to become due or to be delivered, a deed or writing containing a
conveyance of land, any valuable contract in force, a receipt, release or
defeasance, a writ, process, certificate of title or duplicate certificate issued
under chapter one hundred and eighty-five, a public record, anything which
is of the realty or is annexed thereto, a security deposit received pursuant
to section fifteen B of chapter one hundred and eighty-six, electronically
processed or stored data, either tangible or intangible, data while in transit,
telecommunications services, and any domesticated animal, including
dogs, or a beast or bird which is ordinarily kept in confinement.
Mass. Gen. Laws 266 § 30(2) (1999).
In order to obtain a conviction for larceny in Massachusetts, Massachusetts
General Laws 266 § 30 provides that the Commonwealth of Massachusetts must “prove
beyond a reasonable doubt an unlawful taking and carrying away of the property of
39 The court notes that Irene M. Warren resided in Connecticut at the time her Derivium
transaction was executed and the alleged theft of the value of her stock occurred, and,
therefore, the court applies Connecticut law to the theft allegations regarding Irene M.
Warren, which is addressed below.
40The court notes that the Massachusetts General Laws for theft for 1999 and 2000 are
identical.
43
another with the specific intent to deprive the person of the property permanently.”
Commonwealth v. St. Hilaire, 470 Mass. 338 (2015) (footnote omitted); see also
Commonwealth v. Liebenow, 470 Mass. 151, 156 (2014); Commonwealth v. Bonilla, 47
N.E.3d 454, 456 (Mass. App. 2016) (quoting Commonwealth v. Murray, 401 Mass. 771,
772 (1988) (“In order to sustain a conviction for larceny, the Commonwealth must prove
‘that a defendant took the personal property of another without the right to do so, and
‘with the specific intent to deprive the other of the property permanently.’”). “To convict a
defendant of larceny requires that the Commonwealth prove that a defendant took the
personal property of another without the right to do so, and ‘with the specific intent to
deprive the other of the property permanently.’” Commonwealth v. Liebenow, 470 Mass.
at 156 (quoting Commonwealth v. Murray, 401 Mass. 771, 772 (1988)). A Massachusetts
appellate court explained:
In Massachusetts, consistent with ancient common law principles, the
fraudulent inducement of services is not larceny. See Commonwealth v.
Rivers, 31 Mass. App. Ct. 669, 671 & n. 3, 583 N.E.2d 867 (1991) (“theft of
services . . . [is] not . . . considered a criminal offense in the absence of
special legislation”). Rather, in order to be convicted for larceny, some
tangible res must be converted. This is reflected in G.L. c. 266, § 30, the
general larceny statute, which criminalizes the conversion of “the property
of another.” “Property” is defined in § 30, as amended by St. 1995, c. 272,
§ 3, as: “money, personal chattels, a bank note, bond, promissory note, bill
of exchange or other bill, order or certificate, a book of accounts . . . a deed
. . . any valuable contract in force, a receipt, release or defeasance, a writ
. . . a public record . . . a security deposit . . . electronically processed or
stored data, either tangible or intangible, data while in transit,
telecommunications services, and any domesticated animal, including
dogs, or a beast or bird which is ordinarily kept in confinement.”
With the express exception of “data while in transit,” “intangible”
“electronically processed or stored data,” and “telecommunications
services,” every item listed is some form of tangible property. The various
types of construction services performed by all but three of the
subcontractors here simply do not fall within the purview of G.L. c. 266,
§ 30, or the common law definition of the offense.
Commonwealth v. Geane, 744 N.E.2d 665, 670 (Mass. App. 2001) (emphasis and
alterations in original).
Under Massachusetts state law, “[t]he offense of larceny by false pretences is
committed when there is a false statement of fact known or believed by the defendant to
be false made with the intent that the person to whom it is made should rely upon its truth,
and such person does rely upon it as true and parts with personal property as a result of
such reliance.” Commonwealth v. Greenberg, 339 Mass. 557, 574-75 (1959); see also
Commonwealth v. Green, 326 Mass. 344, 348 (1950).
44
Plaintiffs argue that the for the Massachusetts residents “Cathcart’s Stipulation and
[Jon A.] Rochlis’s trial testimony provide the requisite proof of the elements of theft under
Massachusetts Law,” and “Cathcart’s Stipulation and [Kenneth] Ishii’s trial testimony
provide the requisite proof of the elements of theft under Massachusetts Law.” According
to the plaintiffs, the property allegedly stolen “was 10% of the value of the security
transferred to Derivium.” Plaintiffs claim that Charles Cathcart
admitted he fraudulently took property belonging to Rochlis and Warren
[and the Ishiis] when he stipulated that he served as the “controlling mind”
of the 90% Loan Scheme; that he knowingly and intentionally
misrepresented (i) that customers would retain beneficial ownership of their
stocks, (ii) Derivium would engage in a hedging strategy and (iii) that
Derivium’s customers would be protected through a proprietary hedging
strategy; he had reason to know that no hedging took place because he had
a PhD in Economics; and he appropriated 10% of the value of the securities
transferred to Derivium to his own use.
Plaintiffs in the above captioned cases quote and cite to the stipulations of fact extensively
to try and demonstrate the elements of theft under Massachusetts law, noting that
“Charles Cathcart (‘Cathcart’) served as the ‘controlling mind’ and ‘prime-mover’ of the
90% Loan scheme.” Plaintiffs continue to quote from the joint stipulations:
The 90% Loan Program was marketed as a way for customers to: (a) obtain
the benefit of cash in an amount equal to 90% of the value of their securities;
(b) defer paying capital gains on the transaction; and (c) be protected
against the risk that the securities would depreciate while at the same time
preserving their ability to take advantage of any possible appreciation in the
securities’ value.
Derivium’s marketing materials emphasized the customer's ability to
recover their securities at the end of the transaction term, stating that the
customer would "retain beneficial ownership" of his securities, such that “if
your equities increase in value, you keep all the upside,” and “[b]ecause you
still own your stocks, you retain all the potential for further gains.” These
statements were false, since Derivium sold its customers' securities
prior to the inception of the transaction.
(emphasis added by plaintiffs). Plaintiffs, further quote from the joint stipulations, as
follows:
The marketing materials state that Cathcart is a “world-recognized expert in
building and preserving wealth for clients through the application of
sophisticated hedging strategies,” whose “proprietary structures and
models are the foundation of the products offered through Derivium
Capital.” Derivium's marketing materials also state that Derivium will
engage in “hedging” transactions to protect the value of customers’
securities. These statements were also false Derivium never engaged in
45
hedging transactions. Rather, it simply sold its customers securities,
remitted an amount equal to 90% of the proceeds back to its customers,
and kept the remaining 10% for its own purposes, including paying
operating expenses and fees to its owners.
(emphasis added by plaintiffs). Additionally, plaintiffs quote the joint stipulations which
state:
Following the sale of a customer's securities, however, Derivium and the
supposed lenders faced a countervailing risk, which was that stock values
would rise. Because customers’ securities were immediately sold in
every case, if a customer elected under the MLA to recover his securities
at the end of the transaction term, Derivium had to repurchase the securities
on the open market to return those shares to the customer.
In the event that prices for more than a few of the securities submitted as
collateral increased substantially during the transaction term, Derivium
faced an inherent risk of being unable to satisfy the obligations to
customers. Despite this known risk, Derivium never engaged in hedging
transactions.
Cathcart, Scott, Debevc, and Derivium's sales staff informed customers
prior to entering into the transaction that their securities would be “hedged”
pursuant to Cathcart’s proprietary hedging formula. These statements
were false.
(emphasis added by plaintiffs).
Moreover, according to the same joint stipulations:
The 90% Loan Program generated approximately 3100 transactions,
totaling more than $1 billion in sale proceeds, 90% of which was used to
fund the purported loans to customers, leaving at least $100 million as the
difference between the purported loan proceeds and the value of the
securities (the “Net Proceeds”).
Derivium used the Net Proceeds for a variety of purposes. Derivium (and
later Derivium Capital USA and Veridia) kept approximately 20 to 25% of
the Net Proceeds for itself in the form of commissions. Throughout its
operation, Derivium’s only significant source of income was commissions
from the sale of customer’s securities.
Cathcart and Debevc and other employees of Derivium had signature
authority over all domestic bank and brokerage accounts used in connection
with the 90% Loan Program, and Debevc personally effected transfers from
these various accounts into the Start-Up companies at Cathcart’s
recommendation or direction.
46
Cathcart identified and recommended investing in the Start-Up Companies.
The purported “hedging” model implemented by Cathcart involved the
immediate sale of the customer's securities and investment of the Net
Proceeds into Start-Up companies owned and controlled by the Principals.
With regards to call options plaintiffs also cite to the joint stipulations entered into by the
parties in the above captioned cases which indicate:
Cathcart says that call options were not purchased in connection with the
90% Loan Program because it would have been too expensive to do so. To
adequately and truly hedge Derivium's risks related to the 90% Loan
Program, Derivium would have had to purchase call options, correlated with
its customers’ securities. In fact, the Net Proceeds from the 90% Loan
Program would have been insufficient to purchase adequate call options.
Derivium did not maintain reserves of capital that could be drawn upon if
the supposed “hedges” failed.
Plaintiffs quote from the same joint stipulations that:
Finally, the claim that the 90% Loan Program involved “hedging” is false or
fraudulent. No funds were used to hedge any 90% Loan transactions.
Cathcart's claim that the use of the 90% Loan proceeds (through
“investment” in the “Start-Up Companies”) constituted hedges against
securities was pure fiction and constituted nothing more than an economic
gamble.
Cathcart knew that the 90% Loan scheme operated by selling the
customers’ securities immediately upon receipt (“on behalf of” sham
“lenders” Cathcart created), retaining 10% of the proceeds as income in
Derivium-controlled bank and brokerage accounts, and then distributing the
proceeds to Cathcart and his associates directly and to the Start-Up
Companies (which Cathcart and his associates owned and managed).
Cathcart also knew or had reason to know that no “hedging” took place and
that the 90% Loan transactions were taxable sales. Cathcart is a Ph.D.
economist who spent years working on actual derivatives and hedging
instruments before creating the 90% Loan Program. He previously served
as, among other things, President of Citicorp International Trading
Company, Chief Economist of the Eastern Division of Citibank’s US
Treasury, Vice President of the Business Economics Group at W &R Grace,
and an economist with Chase Manhattan Bank.
He knew or had reason to know that the diversion of 90% Loan proceeds
into a variety of start-up construction companies in the same geographic
region, owned by Cathcart and his cohorts (who lacked experience in the
industry) was nothing more than an economic gamble, and any claim that
these were “investments” constituted hedges against unrelated securities
47
was pure fiction. Based on the absence of actual hedging, Cathcart had
reason to know Derivium would lack the funds to perform on (and thus
would of default on) its obligation to return customers’ securities upon
demand at maturity.
Plaintiffs also rely on the trial testimony of Jon A. Rochlis and Kenneth Ishii to
support their claims of theft losses. Plaintiffs cite to the trial testimony of Jon A. Rochlis
that between 1990 and 1991, he purchased 225 shares of Cisco stock for approximately
$10,000. At trial, he testified: “I invested about $10,000 in Cisco that became about $2
million - worth about $2 million about ten years later.” He further testified, “I invested in a
number of stocks. The ones relevant to this case include Network Appliance, Internet
Security Systems, Amazon.com, Intel, Microsoft.”
As described above, according to the testimony of Jon A. Rochlis, he first learned
of Derivium Capital in “an advertisement in the Wall Street Journal for their 90 percent
stock loan.” Mr. Rochlis testified that “Randolph Anderson was the person who responded
to me and was the sales/marketing person at Derivium” and that he “received brochures
and emails from Mr. Anderson in January of 1999.” Mr. Rochlis testified what he believed
was the advantage of pursing the stock loan with Derivium,
one of their attributes that they touted was that you own the stock. You still
own your stock. You transfer it to them in escrow, and they hold it, but you
still own it. Therefore, you - you benefit from - from - from an unlimited
upside potential, which, of course, is marketing-speak, but you gain from
the upside potential, again, minus the cost of the loan, but you have upside
potential. It’s designed that way.
Plaintiffs specifically cite to Jon A. Rochlis’ testimony at trial that he would have
not invested if not for Charles Cathcart’s involvement, as he testified that “wouldn’t have
done it without the marketing brochures, particularly Charles Cathcart’s experience in
creating derivatives, because you couldn’t just buy this off the shelf.” In response to
plaintiffs’ counsel’s question at trial: “So what were the advantages of the model proposed
by Charles Cathcart?” Mr. Rochlis testified
the advantages are you have got downside protection of 90 percent, you
had upside potential if the stock rose above 120 percent of the value when
you went into it, which, as you - as I have said, the stocks had certainly done
- shown their ability to do that in the past. It was also somewhat less
expensive than publicly traded options, and the term was for three years,
and it was easy to do, where you didn't have three-year options, and so you
had to keep rolling over the stock - the options, rather, when they expired
every six months or something like that, which was a - would have been a
lot of work and possibly more expensive as the stock prices would - would
fluctuate.
Plaintiffs also cite to Jon A. Rochlis’ trial testimony regarding the Derivium process, during
which he stated: “So the Derivium hedge worked in that you gave them security for a loan
48
that was in the amount of 90 percent of the value when you transferred the securities,
and they promised to deliver those securities to you in three years if you paid off the loan
plus - plus interest.” Regarding the arrangement with Derivium, Mr. Rochlis believed
“[t]here was a term - there was a term of the agreement that said until they performed the
hedge, we could demand our collateral back. Once they had done the hedge, we couldn’t
do it. Then we were locked into the three years.”
Finally, plaintiffs cite to Jon A. Rochlis’ reliance on Derivium to proceed with the
hedges: Mr. Rochlis testified at trial that “Randolph Anderson represented to me that they
would not sell the stock without hedging it. As a matter of fact, I think he said they would
be crazy or insane. That's a conversation I remember pretty well for how long ago it was.”
Mr. Rochlis continued: “And similarly, I got comfortable with Derivium doing that because
they were the derivatives and hedging gurus and experts, and they admitted that it would
be crazy to sell the stock without putting a hedge in place.”41 In response to the question,
“[w]hy did you file your theft loss claim in 2009?” Mr. Rochlis testified “because that was
the first year, given the stipulations, that we could have known that there was actual -
there was an actual mens rea, there was an actual intent, scienter on the part of Cathcart
to steal - to fraudulently deprive us of our property.” Mr. Rochlis further testified that
“Derivium never told us that they had assigned, pledged, sold, or anything to the collateral.
They gave us statements every quarter for the duration showing how many shares they
were holding for us. In fact, those were adjusted for splits. They showed dividends. That
reduced interest.” Plaintiffs specifically noted Mr. Rochlis’ statement that Derivium
expressly promised to me that they would not sell my securities without a
hedge, but they did, and so they robbed me of the upside potential of my
stocks, and they did that the first day when they sold my shares in order to
give me the 90 percent. They led me to believe that they would hold those
shares or that they would hedge them. They didn’t do that.
Additionally, plaintiffs point to the testimony of Kenneth Ishii, who testified at trial
that he received stock options after he joined the company Accordance, which
subsequently merged with Software.com and his Accordance options “got rolled over into
new options in Software.com.” At the time of his first transaction with Derivium, Mr. Ishii
testified that the value of the Software.com stock “was probably on the order of 10 million
[dollars] at that point.” Mr. Ishii testified that “I also talked to Mr. Rochlis about, you know,
what he had done and what my options there were, and it didn't really sound like, sort of
on the public options market, there was any market for, you know, a brand new startup
like Software.com, so that didn't really seem to be a possibility.”
Regarding Derivium, Mr. Ishii explained, “I got standard marketing literature, and
then eventually I - I don’t remember how it was arranged, but I had a phone call with
Randolph Anderson, and we talked about the different programs they had available and
how - how they applied to my situation, and he described them, and - you know, and we
41Plaintiffs also point to Mr. Rochlis’ testimony at the trial that he consulted an attorney,
Daniel Byrnes, prior to entering into the Derivium transaction. Mr. Rochlis testified that
Mr. Byrnes’ opinion was the Derivium transactions were loans and not constructive sales.
49
moved forward from there.” Mr. Ishii emphasized that Mr. Anderson explained, “the tax
consequences of the event, and he said there were none. He also discussed how the 90
percent was an important number, because the 10 percent made it a significant risk, and
so it wasn't deemed a sale by the IRS.” Plaintiffs further point to Mr. Ishii’s testimony of
his understanding of the Derivium transaction. At trial, Mr. Ishii gave his view on how the
Derivium hedge would work:
My understanding was that they - they had someone - you know, they would
get the money together, and I would give them the stock, and they would
hedge however they were going to do, and whatever the value of that hedge
was, I would get 90 percent of that value as a loan for the - for three years.
And it was, you know, locked up for those three years, and it was
nonrecourse, and that over that time, it would be 10 1/2 percent interest per
year.
Mr. Ishii reiterated his belief that “I still continued to own the stock even though they held
it, and, you know, so there was no sale. There was - and at the end of the loan period, I
could pay back the loan, and I would get my stock back, and - and, you know, if it
increased in value, I would - you know, I would have that gain.”
Plaintiffs also focused on Mr. Ishii’s understanding of his Master Loan Agreement,
and the provision that provided that “[a]t any time the Client can request that any collateral
not yet committed in an FSC hedging transaction be promptly returned resulting in the
reduction of the amount and terms of the loan.” Mr. Ishii testified that “I believe this - this
meant that they had to be able to return the stock to me and up until the time it was
hedged. So a hedge had to exist.” Mr. Ishii testified that he entered into four total hedges
with Derivium. For each one he testified that he “believed that they [Derivium] had hedged
my stock, that they had entered into some contract protecting it.” Finally, plaintiffs cite to
Mr. Ishii’s understanding of what Derivium took from him: “I believe they stole the upside
on my stock, that they really - you know, by selling it with no guaranteed way of getting it
back, at that point, it was - you know, if it had taken off, they were - I was - there was no
way for them to get it back for me.”
In sum, plaintiffs argue that “Cathcart’s Stipulation and [Jon A.] Rochlis’s trial
testimony provide the requisite proof of the elements of theft under Massachusetts Law.”
Plaintiffs, consistent with the definitions above, argue: “The crime of larceny by false
pretenses requires (1) a false statement of fact, (2) known or believed by defendant to be
false, (3) accompanied with intent that person to whom it is made should rely upon its
truth, and (4) where person to whom it is made does rely upon it as true, and (5) parts
with personal property as result of such reliance.” Plaintiffs argument boils down to: “The
property stolen was 10% of the value of the security transferred to Derivium. Elements
(1) and (2) above are proven by the by Cathcart’s Stipulation[s]. Elements (3), (4), and
(5) are proven by [Jon A.] Rochlis’s trial testimony.” (internal citations omitted).
Similarly, regarding the Ishiis’ claims, plaintiffs argue that
50
Cathcart’s Stipulation and [Kenneth] Ishii’s trial testimony provide the
requisite proof of the elements of theft under Massachusetts Law. The
property stolen was 10% of the value of the security transferred to Derivium.
Elements (1) and (2) above are proven by the by Cathcart's Stipulation[s].
Elements (3), (4), and (5) are proven by the Ishiis's trial testimony. In
summary, the Ishiis have satisfied their burden of proof under Mass. Gen.
Laws Ch. 266, § 30(1).
(internal citations omitted).
The court believes plaintiffs’ approach to try to link the joint stipulations and
statements in the trial transcript to the standard for theft in Massachusetts is too
underdeveloped. The plaintiffs, defendant, and the court, all agree that Derivium
committed a fraud and engineered a scheme. The parties’ stipulations, in addition to the
ones quoted extensively above by the plaintiffs, state that “Cathcart knew or had reason
to know that the 90% Loan Program’s claims were false or fraudulent under Section 6700
[26 U.S.C § 6700].” Most pointily, the parties stipulate that: “As the scheme’s founder,
creator, and President, and as the alter ego of all of the sham ‘foreign lenders,’ Cathcart
knew that several of the scheme’s claims were false or fraudulent.” (emphasis in original).
Plaintiffs, however, fail to link the actions taken by Charles Cathcart and Derivium to the
theft of any property owned by plaintiffs.
Defendant argues that
[i]t is clear that there could have been no theft under Massachusetts law in
this case because no tangible personal property belonging to plaintiffs was
taken from them. ‘Potential appreciation’ in the value of stock that was never
realized is not tangible personal property that can be the subject of theft
under Massachusetts law. No portion of plaintiffs’ stock could have been
taken from them because they voluntarily surrendered all that stock to
Derivium.
Defendant continues: “Regardless of whether Mr. Cathcart committed fraud when he
knowingly misrepresented that Derivium would hedge the investors’ stocks before selling
them it is clear that conduct cannot constitute theft.” The court also finds defendant’s
arguments on this issue too summary.
The court, however, ultimately agrees with defendant. On cross-examination, Mr.
Rochlis testified that the only personal property that he owned that was transferred to
Derivium was the stock and Mr. Ishii indicated the same. All plaintiffs also elected the
option to surrender their securities to Derivium at the end of the three year old period. On
the form from Derivium Maturing Loan Department, instead of selecting the option to
repay the loan, or renew or refinance the loan, both Mr. Rochlis and Mr. Ishii selected the
option: “I/we hereby officially surrender my/our collateral in satisfaction of my/our entire
51
debt obligation.”42 The entirety of the stocks were relinquished to Derivium. The plaintiffs
testified to the same at trial. Mr. Ishii testified “I elected to - to surrender the collateral.” In
response to the question, “as a result of surrendering the collateral and walking away
from the loan, you were not required to make any payment to Derivium at the end of the
transaction,” Mr. Ishii responded: “Correct.”43 In addition to their testimony, the plaintiffs’
tax returns likewise demonstrate the plaintiffs reported their stocks as sold after their
voluntary surrender. For the 2002 and 2003 tax years plaintiffs reported the principal and
interest due on the purported loans as the proceeds of the sale of their stocks.44
Even though the stocks were surrendered to Derivium, Mr. Ishii claimed that “I
believe they stole the upside on my stock, that they really - you know, by selling it with no
guaranteed way of getting it back, at that point, it was - you know, if it had taken off, they
were - I was - there was no way for them to get it back for me,” and Mr. Rochlis claimed
42 As discussed below when addressing Irene M. Warren and Connecticut law, on the
form from Derivium Maturing Loan Department, instead of selecting the option to repay
the loan, or renew or refinance the loan, Irene M. Warren selected the option: “I/we hereby
officially surrender my/our collateral in satisfaction of my/our entire debt obligation.”
43 Although conceding he signed the paperwork indicating “I/we officially surrender my/our
collateral in satisfaction of my/our entire debt obligation,” Mr. Rochlis contended at trial:
“I will point out that I didn’t voluntarily surrender it, as you maintain, because they had
already stolen it. I mean, you can’t surrender something that someone stole under false
pretenses.”
44The court notes that at trial, and in its post-trial briefs, defendant highlights that “plaintiffs
claimed as deductions on their returns for 1999-2003 the interest that accrued on the
purported Derivium loans, even though they did not pay that interest.” In addition,
defendant notes that “[a]s a result of those deductions, the amount they reported as the
proceeds of the sales of their stocks was equal to the 90% cash they received. To reduce
their tax related to that purported sale, plaintiffs subtracted from the sale proceeds their
basis in those stocks. Plaintiffs’ [sic] used 100% of their basis in their stocks to reduce
their tax liability in 2002 and 2003.” In response to defendant’s counsel’s question: “But
by 2003, had all of the interest - Derivium-related interest which is reported on the account
statements, had that all been deducted on your returns?” Jon A. Rochlis testified: “I would
expect so. I would - I would have to actually verify it, go through them, but by the end of
2003, I would expect so.” Similarly, Kenneth Ishii had the following exchange with
defendant’s counsel at trial:
[Q.] Did you pay any of the interest that accrued each year?
A. No. That would have been due at the end of the three years.
Q. Okay. But even though you didn't pay the interest, you deducted it each
year on your returns as an investment interest expense?
A. I believe so.
52
that Derivium “expressly promised to me that they would not sell my securities without a
hedge, but they did, and so they robbed me of the upside potential of my stocks, and they
did that the first day when they sold my shares in order to give me the 90 percent.” The
court notes, however, that plaintiffs voluntarily surrendered the stock to Derivium at the
end of the loan period. Furthermore, Jon A. Rochlis testified he would have surrendered
his securities even if a hedge had occurred, because the value of the securities was worth
less than the loan amount. Jon A. Rochlis had the following exchange with defendant’s
counsel on cross-examination:
Q. - at the end of the transaction, you would have still surrendered the stock,
correct -
A. I would have still surrendered it, yes, if it was -
Q. - whether it was hedged or not, because you still would have had to have
paid more than that stock was worth in order to get it back.
A. That’s right. Yes, I would have done the same thing.
Moreover, although plaintiffs claim their 10% interest was taken from them, as
defendant notes “[t]he ‘hypothetical option’ that plaintiffs claim was stolen from them
cannot be the subject of a theft loss because one cannot steal something that never
existed.” The stipulations make clear that “Cathcart also knew or had reason to know that
no ‘hedging’ took place.” Plaintiffs likewise argue that “Derivium immediately sold their
securities and did not hedge.” As discussed below, it is also challenging to quantify the
value of the “hypothetical option,” because Derivium did not indicate how they would
hedge plaintiffs’ securities and, of course, did not enter into any kind of hedging
arrangement or pursue a hedging strategy. The hypothetical nature of any potential loss
also demonstrates the challenges that plaintiffs faced during the testimony at trial in
articulating exactly what was taken from them as a result of the non existent hedge. The
plaintiffs in their trial testimony and in their post-trial briefs were forced to speculate about
what the hypothetical profit would be or what type of value they might have realized from
the stock if Derivium had not immediately sold their securities and instead hedged the
securities. Jon A. Rochlis testified it was the “upside potential of my stocks,” and Kenneth
Ishii testified that it was “the upside on my stock.” Both plaintiffs could only comment on
the speculative nature of there being an “upside” on the securities as opposed to
something more tangible or a fixed dollar value that supposedly was taken from them.
Defendant also argues that “[e]ven if Derivium had properly hedged plaintiffs’
stocks by purchasing a call option, that call option would belong to Derivium, not plaintiffs.”
Jon A. Rochlis’ Master Loan Agreement provides at paragraph 3:
The contemplated Loan(s) will be funded according to the terms identified
in one or more terms sheets, which be labeled as Schedule A, individually
numbered and signed by both parties, and, on signing, considered part of
an [sic] merged into this Master Agreement. The Client understands that by
transferring securities as collateral to DC and under the terms of the
53
Agreement, the Client gives DC and/or its assigns the right, without
requirement of notice to or consent of the Client, to assign, transfer, pledge,
repledge, hypothecate, rehypothecate, lend, encumber, short sell, and/or
sell outright some or all of the securities during the period covered by the
loan. The Client understands that DC and/or its assigns have the right to
receive and retain the benefits from any such transactions and that the
Client is not entitled to these benefits during the term of a loan. The Client
agrees to assist the relevant entities in completing all requisite documents
that may be necessary to accomplish such transfers.
Pursuant to the Master Loan Agreements, Derivium had the option to take the funds they
were obligated to hedge and “short sell, and/or sell outright some or all of the securities
during the period covered by the loan,” with the plaintiffs’ understanding that any benefits
would accrue to Derivium during the loan period.45 At trial, Jon A. Rochlis agreed with this
conclusion during cross-examination:
[Q.] Now, if Derivium had done what they promised and let's say they
purchased a call option on the day that they claimed that they hedged the
transaction, that call option would have been the property of Derivium,
correct?
A. Yes.
Q. And Derivium could have done - like you said you can buy the option, you
can sell the option, you can do other things with it. Derivium would have been
the one that would have done those things, not you, correct?
A. That’s correct.
Q. Okay. So any hedge would have been, as far as the underlying financial
instruments, would have all been owned by - whatever hedging transaction
they entered into, whether it was an exotic derivative or it was a call option,
that would all be the property of Derivium.
A. It would be.
In addition, paragraph 4 of Jon A. Rochlis’ Master Loan Agreement states:
45 Although the terms of the Master Loan Agreements do not explicitly state that Derivium
would hedge the securities that plaintiffs transferred to Derivium, defendant concedes that
it “is undisputed that principals of Derivium represented to investors that they would
engage in hedging transactions with respect to the stock.” As indicated above, the Master
Loan Agreements provided that plaintiffs would provide to Derivium the right “to assign,
transfer, pledge, repledge, hypothecate, rehypothecate, lend, encumber, short sell,
and/or sell outright some or all of the securities during the period covered by the loan,”
and that Derivium, during the loan period “had the right to receive and retain the benefits
from any such transactions.”
54
DC agrees to return, at the end of the loan term, the same number of shares
of the same securities received as collateral (as conditioned in the next
sentence), as set out and defined in Schedule(s) A attached hereto, upon
the Client satisfying in full all outstanding loan balances, including accrued
interest. Said collateral shall reflect any and all stock splits, conversions,
exchanges, mergers, or other distributions, except cash dividends credited
toward interest due.
Schedule A, referred to in both Paragraph 3 and Paragraph 4 states that for the all the
loans to Jon A. Rochlis, Irene M. Warren, and Kenneth Ishii that the term of the loan was
“3 years” there was a “3 year lockout.” Schedule A also provided that “[l]ender cannot call
loan before maturity,” and that the loan was “[n]on-recourse to borrower, recourse against
the collateral only.” Although the United States Court of Appeals for the Federal Circuit
has not decided the issue, other United States Courts of Appeals faced with this issue
have decided that “Derivium was treated as the owner of the stock for the duration of the
loan.”46 Calloway v. Comm’r, 691 F.3d 1315, 1329 (11th Cir. 2012); see also Sollberger
v. Comm’r, 691 F.3d 1119, 1125 (9th Cir. 2012). The Eleventh Circuit in Calloway,
indicated that,
the terms of the Master Agreement and accompanying schedules also point
to the conclusion that the transaction was a sale of Mr. Calloway’s stock to
Derivium. The Master Agreement granted Derivium the right to possess the
stock, the equity in the stock, and the right to receive the profits from either
holding or disposing of the stock. As well, the nonrecourse provision of the
loan ensured that, once the transaction was entered, the risk of loss passed
entirely to Derivium. Applying the benefits and burdens test, therefore, we
believe that the transaction between Mr. Calloway and Derivium constituted
a sale of securities.
Calloway v. Comm’r, 691 F.3d at 1330 (footnotes omitted).
In Sollberger v. Commissioner, 691 F.3d 1119,47 the Ninth Circuit explained that
[o]n July 6, 2004, Sollberger entered into the Master Loan Financing and
Security Agreement (the Master Agreement) with Optech. Under the Master
Agreement, Optech agreed to loan Sollberger ninety percent of the face
value of the FRNs [Floating Rate Notes] pursuant to the Schedule A–1 Loan
Schedule (the Loan Schedule). In return, Sollberger agreed to transfer
custody of the FRNs to Optech and give Optech certain rights. The loan
was nonrecourse to Sollberger and secured only by the FRNs.
46 The court further addresses the ownership of the securities below.
47 The court notes that plaintiffs’ counsel of record in the above captioned cases is also
listed as the counsel of record for the taxpayer in Sollberger.
55
Id. at 1121 (footnote omitted). The Sollberger court explained that under the terms of the
loan as follows:
The loan term was seven years, and Sollberger was not allowed to prepay
the principal before the maturity date. Optech agreed to return the FRNs to
Sollberger at the end of the loan term if Sollberger had repaid the loan
amount in full, in addition to any outstanding net interest, and late penalties
due. However, Optech was given the right to sell or otherwise dispose of
the FRNs during the loan term, without giving Sollberger notice, or receiving
his consent.
Id. at 1122. The Sollberger court dismissed the Sollberger plaintiff’s argument that the
Master Loan Agreement entered into by the parties was not a sale:
Sollberger further argues that the transaction was not a sale for tax
purposes because he retained the right to have his collateral returned on
demand since Optech had not fulfilled a condition precedent under the
Master Agreement to fund a loan or implement a hedging strategy. This
argument is based on Sollberger’s misreading of the relevant agreements.
The Master Agreement provided that “[e]ither party may terminate this
Agreement at any time prior to the Lender’s receipt of the Collateral and the
initiation of any of the Lender’s hedging transactions.” The Loan Schedule,
which set forth the final terms of the loan, provided that the seven-year loan
term would “start[ ] from the date on which final Loan proceeds are delivered
on the Loan transaction.” Optech was entitled to hold and sell the FRNs
during the loan term, and Sollberger had no right to demand the return of
the FRNs during that time period. Here, Sollberger instructed his bank to
transfer the FRNs to Optech on July 9, 2004, and Optech acknowledged
receipt of the collateral on July 21, 2004. Optech then sold the FRNs on
July 26, 2004 and delivered the loan proceeds to Sollberger on August 2,
2004. Sollberger did not attempt to void the agreement pursuant to the
termination clause before Optech received and sold the FRNs. Although
Optech may have breached the Master Agreement by selling the FRNs prior
to the start of the loan term, as Sollberger contends, this breach does not
transform the transaction into something other than a taxable sale of
property. Accordingly, Sollberger’s argument is unavailing.
Id. at 1126. The Sollberger court also cited to the Tax Court’s decision in Calloway v.
Commissioner, 135 T.C. 26, to note that
Sollberger’s arguments that the transaction was not a sale for tax purposes
are easily addressed and discarded. Although Optech may have gotten the
better end of the bargain because Sollberger received less than the full
market value of the FRNs and still owes taxes on his gain, Sollberger
received the benefit of his bargain. Perhaps like the taxpayer in Calloway,
Sollberger engaged in the transaction because he believed he could receive
ninety percent of his asset’s value tax free. See Calloway, 135 T.C. 38.
56
If that was his belief, he was sorely mistaken, and the scheme only appears
to be a theft in hindsight because it did not allow him to evade taxes. The
fact that the sale of an asset, in the fullness of time, appears to have been
a bad decision for a seller does not change the character of the transaction
for tax purposes. Thus, we reject Sollberger’s argument that the sale was
not really a sale because Optech profited at his expense.
Sollberger v. Comm’r, 691 F.3d at 1125-26 (footnotes omitted). Based on the record
before the court, the court agrees with defendant, and the decisions in Sollberger and
Calloway, that Derivium, and not the plaintiffs were the owners of the securities after the
Master Loan Agreements were entered into by Derivium and the plaintiffs.
Defendant also argues that “the evidence in the record of this case is not sufficient
to meet plaintiffs’ burden of proving that Mr. Cathcart had the specific intent to deprive
plaintiffs of any property belonging to them at the time plaintiffs’ stocks were transferred
to Derivium.” As noted above, in order to obtain a conviction for larceny Massachusetts
General Laws 266 § 30, the Commonwealth must “prove beyond a reasonable doubt an
unlawful taking and carrying away of the property of another with the specific intent to
deprive the person of the property permanently.” Commonwealth v. St. Hilaire, 470 Mass.
338 (emphasis added; footnote omitted); see also Commonwealth v. Liebenow, 470
Mass. at 156. Defendant contends that:
While the record establishes that Mr. Cathcart falsely represented that
Derivium would hedge plaintiffs’ stocks before selling them, there is no
evidence that at the time Derivium received plaintiffs’ stocks Mr. Cathcart
had no intention of complying with its obligation under paragraph 4[48] of the
Agreement to return the same number of shares of the same stocks to
plaintiffs at the end of the three-year lockout period upon their making the
required payment.
In response, plaintiffs contend that “Cathcart intentionally made false statements
about hedging knowing that Derivium would immediately sell Plaintiffs’ collateral without
hedging. Given his financial experience he knew that he could not meet his obligations
under the contract. At a minimum his actions show an exceptional indifference to its ability
48As noted in the findings of fact, Jon A. Rochlis’ Master Loan Agreement, at paragraph
4 states:
DC agrees to return, at the end of the loan term, the same number of shares
of the same securities received as collateral (as conditioned in the next
sentence), as set out and defined in Schedule(s) A attached hereto, upon
the Client satisfying in full all outstanding loan balances, including accrued
interest. Said collateral shall reflect any and all stock splits, conversions,
exchanges, mergers, or other distributions, except cash dividends credited
toward interest due.
57
to return the collateral.”49 (internal citations omitted). Plaintiffs claim “[t]hat is sufficient
proof under the preponderance of evidence standard. Therefore, Plaintiffs have submitted
creditable evidence that Cathcart had the requisite intention and the burden. . . .” The
court, however, finds the plaintiffs’ arguments in this regard insufficient.
Defendant also questions whether anything of value of plaintiffs was taken by
Derivium. As an initial matter, defendant argues that “[o]ne of the peculiar aspects of this
case is the fact that plaintiffs actually benefitted economically from the Derivium
transaction that they now contend constituted a theft. There cannot be a deductible theft
loss if plaintiffs did not sustain any economic loss in the first place.” Defendant notes that
“[i]f plaintiffs had sold 100% of their stocks in 1999 or 2000, they would have had to pay
tax on their substantial gain at that time, and they would have realized less than 80% of
the value of their stocks,” but the
Derivium transaction allowed plaintiffs to realize 90% of the value of their
stocks; to have the use of that money for a period of three years before
having to pay any tax; and to deduct interest expense equal to about 33%
of the loan amount, reducing their taxable income each year even though
they never paid that interest.
Even if plaintiffs were able to connect the stipulations and testimony of Jon A.
Rochlis and Kenneth Ishii to larceny by false pretence, it is unclear how the plaintiffs could
prove something of value taken from them.
Furthermore, even if the plaintiffs were able to prove theft by false pretence or by
embezzlement, the defendant points to an additional hurdle for plaintiffs. Citing to
Washington Mutual, Inc. v. United States, defendant argues that even if a theft had
occurred, plaintiffs have not demonstrated the amount of any potential theft. Plaintiffs
respond that “[p]laintiffs were obviously damaged by Derivium’s theft.”50 Much like
plaintiffs broad statements discussed above, the court is not convinced by plaintiffs’
damages claim. Plaintiffs argue, however, that the theft was “10% of the value of the
collateral, but also three-years of possible appreciation, basically a call option (the right
to buy a security at a specified price at a given time in the future). These are readily valued
and have value when issued (the start of the loan) totally independent of their value at
49 The court notes that plaintiffs did not introduce into evidence at the trial any document
that demonstrated Charles Cathcart’s state of mind, or that of anyone else associated
with Derivium, during the plaintiffs’ Derivium transactions. Plaintiffs only called Jon A.
Rochlis, Kenneth Ishii and Mr. Wayne Fjeld, plaintiffs’ expert, discussed below, during the
three day trial. Plaintiffs appeared content to rely on the information in the joint stipulations
to show Charles Cathcart’s and Derivium’s actions.
50 As indicated above, a Judge of the United States Court of Federal Claims in
Washington Mutual, Inc. v. United States stated that “plaintiffs bear the burden to prove,
by a preponderance of the evidence, that they are entitled to the tax deductions at issue
in this case and the correct amount of the tax refund due.” Washington Mut., Inc. v. United
States, 130 Fed. Cl. at 686-87 (citing United States v. Janis, 428 U.S. at 440).
58
the expiration (the end of their loan).” Defendant notes, however, that the “only evidence
presented by plaintiffs as to the amount of the loss of any ‘potential appreciation’ in the
value of their stock is the testimony of Mr. Fjeld. Mr. Fjeld only attempted to determine
what a ‘hypothetical’ call option on plaintiffs’ stocks would have cost.” On cross-
examination of Mr. Wayne Fjeld, plaintiffs’ expert who was qualified at trial as “an expert
in the area of valuation of call options,” defendant’s counsel asked:
[Q.] But there were other types of transactions Derivium could have entered
into in order to protect the upside of the stock other than a call option.
A. I believe so.
Q. But you did not make any effort to quantify what the cost of those other
types of hedging transactions were.
A. I did not, and with honesty, some of those other strategies that I
mentioned earlier, there is still some risk involved for Derivium, and what
level of risk they're willing to undertake, I - I have no way of commenting on
that.
Q. Okay. And, in fact, just buying a straight call option without doing any of
the other things, you know, such as selling “out of the money” options to
reduce the cost, just the straight call option would be the most expensive
way that Derivium could have hedged this transaction.
A. Having not looked at other alternatives, I can’t say with certainty, but if I
had to wager - I suspect that buying the outright call option would be the
most expensive way.
In addition to plaintiffs’ expert not having analyzed other possible hedging options,
Jon A. Rochlis and Kenneth Ishii testified that Derivium did not specifically indicate that
Derivium would be choosing a call option for the hedge. Mr. Rochlis testified that “I don’t
recall whether they called it a call option. I - I don’t care whether they called it - I wouldn’t
have cared whether they called it a call option. That's what it was.” In response to the
question: “Did Mr. Anderson ever tell you that Derivium was going to purchase call options
or did he just refer to hedging transactions in general?” Mr. Rochlis testified: “He would
have used the word ‘hedge.’ I don't recall him using the word ‘call option.’ He might have,
but I don't think so.” Mr. Ishii similarly testified in response to the question: “At any time,
did anyone at Derivium - Mr. Anderson, Mr. Cathcart, Scott Cathcart or Charles Cathcart
- ever tell you that Derivium was going to be purchasing a call option with respect to your
stock?” Mr. Ishii testified: “They did not tell - talk about what kind of option, but they did
describe their - their - the contract in terms of puts and calls.” Kenneth Ishii then had the
following exchange with defendant’s counsel:
Q. But they did, in fact - so all they really said was is they were going to
enter into a hedging transaction?
59
A. Yes.
Q. And you didn’t really know what the type of hedging transaction might
be.
A. No.
Therefore, defendant argues that
Derivium never promised to purchase call options to hedge plaintiffs’ stock,
plaintiffs have the burden to prove the cost of the other hedging transactions
that Derivium could have used to protect the value of plaintiffs’ stocks. The
failure of plaintiffs to present any evidence as to the cost of those other
hedging transactions precludes them from meeting their burden of proving
the amount of any refund they would be entitled to under their theory.
Although the court agrees with the defendant that the failure by plaintiffs to present
evidence of the cost of other possible hedging transactions demonstrates a failure of
meeting their burden of proof, the court further finds the lack of plaintiffs’ ability to quantify
damages demonstrates that plaintiffs have failed to meet their burden of proof.
State Law of Connecticut
The court notes that Irene M. Warren resided in Connecticut when her Derivium
transition took place.51 The definition of larceny under Connecticut state law is, in relevant
part:
A person commits larceny when, with intent to deprive another of property
or to appropriate the same to himself or a third person, he wrongfully takes,
obtains or withholds such property from an owner. Larceny includes, but is
not limited to:
51 In its supplemental brief, plaintiff, claims that “Derivium also could have been tried in
Massachusetts for Mrs. Warren’s case because Derivium communicated with Mr. Rochlis
in Massachusetts when he was acting as his mother’s agent. Therefore, Derivium’s
communications with Mr. Rochlis about Mrs. Warren had affect [sic] in Massachusetts
sufficient to confer criminal jurisdiction to Massachusetts for Mrs. Warren’s transaction.”
The court, however, believes that Connecticut is the proper state law by which to evaluate
Irene M. Warren’s transactions and also notes that the only evidence plaintiffs cite for Jon
A. Rochlis being his mother’s agent is Ms. Rochlis’ tax returns showing Mr. Rochlis as
Mrs. Warren’s third party designee authorized to communicate with the IRS. Plaintiffs
claim that “[t]aken together such designations are evidence that Mr. Rochlis regularly
acted as his mother’s agent.” The court finds, however, that this is insufficient evidence
to find Jon A. Rochlis as an agent for the Derivium transaction.
60
(1) Embezzlement. A person commits embezzlement when he wrongfully
appropriates to himself or to another property of another in his care or
custody.
(2) Obtaining property by false pretenses. A person obtains property by
false pretenses when, by any false token, pretense or device, he obtains
from another any property, with intent to defraud him or any other person.
(3) Obtaining property by false promise. A person obtains property by false
promise when, pursuant to a scheme to defraud, he obtains property of
another by means of a representation, express or implied, that he or a third
person will in the future engage in particular conduct, and when he does not
intend to engage in such conduct or does not believe that the third person
intends to engage in such conduct. In any prosecution for larceny based
upon a false promise, the defendant’s intention or belief that the promise
would not be performed may not be established by or inferred from the fact
alone that such promise was not performed.
(4) Acquiring property lost, mislaid or delivered by mistake. A person who
comes into control of property of another that he knows to have been lost,
mislaid, or delivered under a mistake as to the nature or amount of the
property or the identity of the recipient is guilty of larceny if, with purpose to
deprive the owner thereof, he fails to take reasonable measures to restore
the property to a person entitled to it.
C.G.S.A. § 53a-119 (2000). The Connecticut General Statutes provide the definitions
related to larceny to include:
“Property” means any money, personal property, real property, thing in
action, evidence of debt or contract, or article of value of any kind. . . . (2)
“Obtain” includes, but is not limited to, the bringing about of a transfer or
purported transfer of property or of a legal interest therein, whether to the
obtainer or another. (3) To “deprive” another of property means (A) to
withhold it or cause it to be withheld from him permanently or for so
extended a period or under such circumstances that the major portion of its
economic value or benefit is lost to him, or (B) to dispose of the property in
such manner or under such circumstances as to render it unlikely that an
owner will recover such property. (4) To “appropriate” property of another
to oneself or a third person means (A) to exercise control over it, or to aid a
third person to exercise control over it, permanently or for so extended a
period or under such circumstances as to acquire the major portion of its
economic value or benefit, or (B) to dispose of the property for the benefit
of oneself or a third person. (5) An “owner” means any person who has a
right to possession superior to that of a taker, obtainer or withholder. . . .
C.G.S.A. § 53a-118 (2000). As explained by the Connecticut state courts:
61
“Connecticut courts have interpreted the essential elements of larceny as
(1) the wrongful taking or carrying away of the personal property of another;
(2) the existence of a felonious intent in the taker to deprive the owner of
[the property] permanently; and (3) the lack of consent of the owner. . . .
Because larceny is a specific intent crime, the state must show that the
defendant acted with the subjective desire or knowledge that his actions
constituted stealing. . . . Larceny involves both taking and retaining. The
criminal intent involved in larceny relates to both aspects. The taking must
be wrongful, that is, without color of right or excuse for the act . . . and
without the knowing consent of the owner. . . . The requisite intent for
retention is permanency.”
State v. Hayward, 169 Conn. App. 764, 772-73 (2016) (quoting State v. Flowers, 161
Conn. App. 747, 752 (2015), cert. denied, 320 Conn. 917, 131 A.3d 1154 (2016)
(alternations in original). The court in State v. Hayward also indicated that “‘[i]ntent may
be inferred by the fact finder from the conduct of the defendant.’” Id. at 773 (quoting State
v. Kimber, 48 Conn. App. 234, 240, cert. denied, 245 Conn. 902 (1998)). The Connecticut
Supreme Court has indicated that “in order to sustain a conviction under Connecticut’s
larceny provisions, therefore, we require proof of the existence of a felonious intent to
deprive the owner of the property permanently.” State v. Calonico, 256 Conn. 135, 159
(2001).
Plaintiffs argue that for Irene M. Warren, “[i]n this case, the proof that Cathcart
committed the crime of embezzlement under Conn. Gen. Stat. §. [sic] 53a-123a is the
same as the proof required in the Goeller [v. United States, 109 Fed. Cl. 534] analysis. In
summary, if the court applies the same analysis for determining whether a theft occurred
in Goeller, above, [Irene M.] Warren will also have satisfied her burden of proof under
Conn. Gen. Stat.§ 53a-123a.” Plaintiffs do not cite to any specific cases or arguments
unique to Connecticut, however, plaintiffs claim earlier in their briefs, unrelated to
Connecticut law that
Derivium’s many false representations of a proprietary hedging strategy to
protect against downside risk induced Rochlis and Warren to without
consent, part with their valuable securities. They did not provide consent
because, while they expected Derivium to hold their securities or if sold to
hedge, in fact Derivium immediately sold their securities and did not hedge.
Rather it used the sale proceeds in excess of the 90% returned to Rochlis
and Warren, for its own purposes. This meets the three-element definition
from Goeller. . . .
(footnote omitted). As determined above, Goeller is not the standard that the court
applies. Moreover, as with the Massachusetts analysis, the plaintiffs point to the
stipulations of Charles Cathcart and the testimony of Jon A. Rochlis, but nothing specific
to Irene M. Warren or Connecticut law. Although there was extremely little relevant
testimony offered bearing on Irene M. Warren’s claims, in reviewing the statutes, the court
62
agrees with the parties that the elements of larceny in Connecticut are substantially the
same as in Massachusetts.52 Defendant argues that;
The reasons set forth above as to why the evidence in this case falls far
short of meeting plaintiffs’ burden of proving the crime of theft under
Massachusetts law are fully applicable to the question of whether there was
a theft in this case under Connecticut law. Since no property belonging to
plaintiffs was even taken from them, and since Mr. Cathcart did not have
the specific intent to deprive plaintiffs of their stocks when they were
transferred to Derivium, the crime of theft cannot be established under
either Massachusetts or Connecticut law.
In addition to the above discussion, the court notes an additional problem for Irene
M. Warren’s claims. As indicated above, the parties stipulate that “Irene M. Rochlis (aka
Warren) passed away on March 13, 2011. Jon A. Rochlis, her son, was appointed as the
Executor of her Estate.” As Irene M. Warren had passed away in 2011, she was
unavailable to testify at trial, and, therefore, unable to testify as to her intent when entering
into the Derivium transaction. Although, “‘[i]ntent may be inferred by the fact finder from
the conduct of the defendant,’” State v. Hayward, 169 Conn. App. at 773 (quoting State
v. Kimber, 48 Conn. App. at 240), the plaintiffs’ approach to demonstrating the elements
of theft were limited to citation to the joint stipulations and admissions of Charles Cathcart
and the testimony of Jon A. Rochlis.
The only information regarding Irene M. Warren’s involvement in the Derivium
transaction are the documents she signed at the beginning and end of the transaction.
She executed the Master Agreement with Derivium on June 9, 2000, transferring to
Derivium 3,148 shares of Cisco Systems, Inc. stock in exchange for 90% of the value of
the stock. That Master Agreement specifically provided that Irene M. Warren transfer
right, title and interest in the stock Cisco Systems, Inc. to Derivium, which, in turn, had
the right to sell or dispose of the stock. A week later, on June 16, 2000, Derivium sent
Irene M. Warren a letter confirming that the proceeds of the Derivium transaction were
transferred to her.53
The only other documents related to Irene M. Warren’s Derivium transaction were
the letter sent to Irene M. Warren regarding the end of the three year loan period, and her
options under the Master Agreement to: (1) pay the principal and interest due on the loan
52 In their supplemental brief, plaintiffs indicate “[m]ost of the applicable state laws on
larceny are very similar, but there are a few differences.” After review of the statutes the
court finds no significant, relevant, substantive differences between Massachusetts and
Connecticut law regarding the plaintiffs’ larceny claims.
53Irene M. Warren also received a letter from Derivium on June 14, 2000, which reflected
the value of her 3,148 shares of Cisco Systems, Inc. stock were worth $203,636.25, and
that she would receive $183,272.63 as a loan from Derivium, or 90% of the value of the
stock.
63
and obtain a return of Cisco Systems, Inc. stock, (2) renew or refinance the loan upon
payment $9,137.07, or, (3) surrender the stock,54 and Irene M. Warren’s response,
surrendering her Cisco Systems, Inc. stock to Derivium in which Irene M. Warren stated:
“I/we hereby officially surrender my/our collateral in satisfaction of my/our entire debt
obligation.”
It is difficult to infer Irene M. Warren’s intent from those three documents.
Moreover, Irene M. Warren passed away on March 13, 2011, before she or Jon Rochlis
learned about the Derivium fraud. At trial, plaintiffs’ counsel asked Mr. Rochlis, regarding
the failure of Derivium to complete the transaction, “[w]hen did you find out that they hadn’t
done the hedge?” and Mr. Rochlis responded that “[y]ou and some other attorneys
contacted me in late 2012, early 2013.” At trial, plaintiffs’ counsel asked why Irene M.
Warren was included on an email between Mr. Rochlis and Randolph Anderson, Mr.
Rochlis’ contact at Derivium, Mr. Rochlis testified that “[b]ecause my mother was also
interested in a Derivium transaction and was - was considering that, and this is asking
Derivium to work up whether they can do it for these stocks and the terms and the like for
- for actually two different loan scenarios. She only actually entered into one later.”
Plaintiffs also allege, “Mrs. Warren relied upon her son, Mr. Rochlis for financial advice.
This is shown by Mr. Rochlis’s communication with Derivium on his mother’s behalf and
his preparation of her tax returns and designation as a third-party contact for the IRS.”
The court concludes that plaintiffs’ examples of Irene M. Warren’s intent, combined with
the inadequacy of connecting the Connecticut statutes to the facts of Irene M. Warren’s
case are not sufficient to support her claim.
Constructive Sale
Plaintiffs argue that an alternative way to calculate the amount of a potential
refund, would be that the court could treat the Derivium transactions as a “constructive
sale of their securities for purposes of calculating their tax basis for the theft loss
deduction.” According to plaintiffs in their post-trial reply briefs, plaintiffs seek the following
damages: “Jon Rochlis requests that he be allowed to deduct a theft loss on his 2009 tax
return in the amount of either $229,165 (actual sale/exchange, cost as basis including
recognized dividends) or $206,325 (constructive sale basis including recognized
dividends),” “[t]he Estate of Irene Warren requests that Irene Warren be allowed to deduct
a theft loss on her 2009 tax return in the amount of either $20,305 (actual sale/exchange,
cost as basis) or $18,274 (constructive sale basis),” and “[t]he Ishiis request that they be
allowed to deduct a theft loss on their 2009 tax return in the amount of $1,011,938 (actual
sale/exchange, coast [sic] as basis) or $910,744 (constructive sale basis).” Plaintiffs, in
their supplemental briefs, further argue that “[i]f the 90% loan transaction is treated as a
sale to Rochlis, Warren, and Ishii of 90% of the fair market value of the stock transferred
and purchase of a forward hedging contract in exchange for 10% of the fair market value
of the stocks transferred to Derivium, then the cost basis should be 10% of the fair market
value of the stocks transferred.” (citation and footnote omitted). The court notes,
therefore, that plaintiffs’ specific valuations depend on the finding of a constructive sale.
54As noted above, the principal and interest due on the loan was $246,560.66, while the
value of the 3,148 shares of Cisco Systems, Inc. stock in April 2003 was $54,563.97.
64
Section 1259 of the United States Tax Code describes a constructive sale:
(a) In general.--If there is a constructive sale of an appreciated financial
position--
(1) the taxpayer shall recognize gain as if such position were sold, assigned,
or otherwise terminated at its fair market value on the date of such
constructive sale (and any gain shall be taken into account for the taxable
year which included such date), and
(2) for purposes of applying this title for periods after the constructive sale-
(A) proper adjustment shall be made in the amount of any gain
or loss subsequently realized with respect to such position for
any gain taken into account by reason of paragraph (1), and
(B) the holding period of such position shall be determined as
if such position were originally acquired on the date of such
constructive sale.
26 U.S.C. § 1259 (2018). Subsection c of 26 U.S.C. § 1259 indicates:
(1) In general--A taxpayer shall be treated as having made a constructive
sale of an appreciated financial position if the taxpayer (or a related person)-
(A) enters into a short sale of the same or substantially
identical property,
(B) enters into an offsetting notional principal contract with
respect to the same or substantially identical property,
(C) enters into a futures or forward contract to deliver the
same or substantially identical property,
(D) in the case of an appreciated financial position that is a
short sale or a contract described in subparagraph (B) or (C)
with respect to any property, acquires the same or
substantially identical property, or
(E) to the extent prescribed by the Secretary in regulations,
enters into 1 or more other transactions (or acquires 1 or more
positions) that have substantially the same effect as a
transaction described in any of the preceding subparagraphs.
26 U.S.C. § 1259(c).
65
Defendant argues that “plaintiffs did not constructively sell their stock, but actually
sold it when they entered into the transaction.” As noted above, other courts have treated
Derivium as the owner of the stock for the duration of the loan term. See Calloway v.
Comm’r, 691 F.3d at 1329. The United States Court of Appeals for the Eleventh Circuit in
Calloway v. Commissioner, provided a comprehensive and relevant analysis as to
whether there was an actual sale to Derivium:
The question presented here is whether Mr. Calloway’s transaction with
Derivium constituted a sale of property, the gain from which should have
been included in his gross income for 2001. See 26 U.S.C. §§ 61(a)(3),
1001. When interpreting the Internal Revenue Code, “the term ‘sale’ is given
its ordinary meaning and is generally defined as a transfer of property for
money or a promise to pay money.” Anschutz Co. v. Comm’r, 664 F.3d 313,
324 (10th Cir. 2011) (citing Comm’r v. Brown, 380 U.S. 563, 570–71, 85 S.
Ct. 1162, 14 L. Ed. 2d 75 (1965)). To determine if a sale has occurred, we
ask “whether, as a matter of historical fact, there has been a transfer of the
benefits and burdens of ownership.” Id. (citing Grodt & McKay Realty, 77
T.C. 1237). Some of the factors that inform the benefits and burdens
inquiry are:
(1) Whether legal title passes; (2) how the parties treat the
transaction; (3) whether an equity was acquired in the
property; (4) whether the contract creates a present obligation
on the seller to execute and deliver a deed and a present
obligation on the purchaser to make payments; (5) whether
the right of possession is vested in the purchaser; (6) which
party pays the property taxes; (7) which party bears the risk
of loss or damage to the property; and (8) which party receives
the profits from the operation and sale of the property.
Grodt & McKay Realty, 77 T.C. 1237–38 (internal citations omitted); see
also Anschutz, 664 F.3d at 324–25. “[N]one of these factors is necessarily
controlling; the incidence of ownership, rather, depends upon all the facts
and circumstances.” H.J. Heinz Co. & Subsidiaries v. United States, 76 Fed.
Cl. 570, 582 (2007). Some factors may be more pertinent in some situations
than others, and, indeed, some factors simply may be ill-suited or irrelevant
to shed light on the ownership of assets under specific circumstances. See
Sollberger v. Comm’r, No. 11–71883, 691 F.3d 1119, 1124–25, 2012 WL
3517865, at *4 (9th Cir. Aug. 16, 2012) (“[W]e agree that [the Grodt & McKay
Realty] criteria may be relevant in a particular case, [but] we do not regard
them as the only indicia of a sale that a court may consider. Creating an
exclusive list of factors risks over-formalizing the concept of a ‘sale,’
hamstringing a court's effort to discern a transaction's substance and
realities in evaluating tax consequences.”).
In addition to the Grodt & McKay Realty test, the Tax Court also has
identified a number of factors to help determine whether a taxpayer has
66
“transfer[red] the accoutrements of stock ownership.” Anschutz v. Comm’r,
135 T.C. 78, 99 (2010), aff’d, 664 F.3d 313, 325 (10th Cir. 2011). They are:
(1) [w]hether the person has legal title or a contractual right to
obtain legal title in the future;
(2) whether the person has the right to receive consideration
from the transferee of the stock;
(3) whether the person enjoys the economic benefits and
burdens of being a shareholder;
(4) whether the person has the power to control the company;
(5) whether the person has the right to attend shareholder
meetings;
(6) whether the person has the ability to vote the shares;
(7) whether the stock certificates are in the person’s
possession or are being
held in escrow for the benefit of that person;
(8) whether the corporation lists the person as a shareholder
on its tax returns;
(9) whether the person lists himself as a shareholder on his
individual tax return;
(10) whether the person has been compensated for the
amount of income taxes due by reason of the person’s
shareholder status;
(11) whether the person has access to the corporate books;
and
(12) whether the person shows by his overt acts that he
believes he is the owner of the stock.
Dunne v. Comm’r, 95 T.C.M. 1236, 1242 (2008), 2008 WL 656496,
at *11 (T.C.2008) (internal citations omitted). As with the Grodt & McKay
Realty factors, “[n]one of these factors alone is determinative,” rather “their
weight in each case depends on the surrounding facts and circumstances.”
Dunne, 95 T.C.M. at 1242, 2008 WL 656496, at *11.
67
For obvious reasons, there is significant overlap between the Grodt &
McKay Realty factors that help determine whether a sale of an asset has
taken place, and the Dunne factors that help determine whether, for tax
purposes, an individual owns stock. Compare, e.g., Grodt & McKay Realty,
77 T.C. 1237 (listing first factor as “[w]hether legal title passes”), with
Dunne, 95 T.C.M. at 1242, 2008 WL 656496, at *11 (listing first factor
as “[w]hether the person has legal title or a contractual right to obtain legal
title in the future”). Indeed, the Dunne factors address the same question as
the Grodt & McKay Realty factors—who has assumed the benefits and
burdens of ownership—but tailor the terminology more precisely to the
attributes of stocks and stock ownership. For instance, in Grodt & McKay
Realty, the tax court identified “how the parties treat the transaction,” or,
slightly rephrased, whether the parties act as if a change in ownership has
occurred, as a factor to consider. 77 T.C. 1237. In Dunne, the court
specified the ways in which a party may exercise his ownership rights in
stock—whether the taxpayer has the ability to vote shares and whether the
taxpayer shows by his overt acts that he believes he is the owner of the
stock. See Dunne, 95 T.C.M. at 1242, 2008 WL 656496, at *11.
Applying the Grodt & McKay Realty factors, as further refined by Dunne, to
the present case, we believe that the most relevant of those factors point
firmly to the conclusion that the 2001 transaction was a sale of stock for the
purposes of Federal income tax. First among those considerations is the
way that the parties treated the transaction in the foundational documents.
Although denominated an agreement “To Provide Financing and Custodial
Services,” the terms of the Master Agreement make it clear that, during the
period of time covered by the “loan,” Derivium was the owner of the stock.
We previously have observed that “the characteristics typically associated
with ‘stock’ are that it grants ‘the right to receive dividends contingent upon
an apportionment of profits’; is negotiable; grants ‘the ability to be pledged
or hypothecated’; ‘confer[s][ ] voting rights in proportion to the number of
shares owned’; and has ‘the capacity to appreciate in value.’” See Fin. Sec.
Assur., Inc. v. Stephens, Inc., 500 F.3d 1276, 1285 (11th Cir. 2007) (per
curiam) (alteration in original) (quoting Landreth Timber Co. v. Landreth,
471 U.S. 681, 686, 105 S. Ct. 2297, 2302, 85 L. Ed. 2d 692 (1985)). When
Mr. Calloway transferred his securities to Derivium pursuant to the Master
Agreement, he ceded these rights of stock ownership to Derivium. Mr.
Calloway gave Derivium “the right, without requirement of notice to or
consent of the Client, to assign, transfer, pledge, repledge, hypothecate,
rehypothecate, lend, encumber, short sell, and/or sell outright some or all
of the securities during the period covered by the loan.” Furthermore,
Derivium was entitled “to receive and retain the benefits from any such
transactions,” but “the Client [wa]s not entitled to these benefits during the
term of [the] loan.” Finally, for the duration of the agreement, Derivium had
the right to vote Mr. Calloway’s shares and to receive any dividends paid on
those shares. Moreover, there was no opportunity for Mr. Calloway to pay
the loan early and demand the return of his stock: Schedule A–1 contained
68
a “3 year lockout” that prohibited prepayment of the loan before maturity.
According to the terms of the parties’ agreement, therefore, Derivium was
treated as the owner of the stock for the duration of the loan.
When evaluated according to other Grodt & McKay Realty factors, the terms
of the Master Agreement and accompanying schedules also point to the
conclusion that the transaction was a sale of Mr. Calloway’s stock to
Derivium. The Master Agreement granted Derivium the right to possess the
stock, the equity in the stock, and the right to receive the profits from either
holding or disposing of the stock. As well, the nonrecourse provision of the
loan ensured that, once the transaction was entered, the risk of loss passed
entirely to Derivium. Applying the benefits and burdens test, therefore, we
believe that the transaction between Mr. Calloway and Derivium constituted
a sale of securities.
Calloway v. Comm’r, 691 F.3d at 1327-30 (footnotes omitted; alternations in original).
This court agrees with the analysis by the Calloway court. As determined above,
the court believes the plaintiffs transferred their interest in the stocks to Derivium.
Consistent with language of the Master Loan Agreement in Calloway,55 the Master Loan
Agreements for the above captioned plaintiffs provide at paragraph 3:
The contemplated Loan(s) will be funded according to the terms identified
in one or more term sheets, which be labeled as Schedule A, individually
numbers and signed by both parties, and, on signing, considered part of an
[sic] merged into this Master Agreement. The Client understands that by
transferring securities as collateral to DC and under the terms of the
Agreement, the Client gives DC and/or its assigns the right, without
requirement of notice to or consent of the Client, to assign, transfer, pledge,
repledge, hypothecate, rehypothecate, lend, encumber, short sell, and/or
sell outright some or all of the securities during the period covered by the
loan. The Client understands that DC and/or its assigns have the right to
55 In Calloway, the Eleventh Circuit quoted paragraph 3 from the Master Loan Agreement
at issue in the Calloway case:
The Client understands that by transferring securities as collateral to
[Derivium] and under the terms of the Agreement, the Client gives
[Derivium] and/or its assigns the right, without requirement of notice to or
consent of the Client, to assign, transfer, pledge, repledge, hypothecate,
rehypothecate, lend, encumber, short sell, and/or sell outright some or all
of the securities during the period covered by the loan. The Client
understands that [Derivium] and/or its assigns have the right to receive and
retain the benefits from any such transactions and that the Client is not
entitled to these benefits during the term of a loan. . . .
Calloway v. Comm’r, 691 F.3d at 1318 (emphasis and alterations in original).
69
receive and retain the benefits from any such transactions and that the
Client is not entitled to these benefits during the term of a loan. The Client
agrees to assist the relevant entities in completing all requisite documents
that may be necessary to accomplish such transfers.
Similarly, each of the Schedule A documents for the plaintiffs in the above captioned
cases contained the same 3 year lockout period that the Calloway court identified as
significant for ownership. Therefore, like the Calloway court, this court believes the risk
was transferred from the plaintiffs “entirely to Derivium.” Id. at 1330. The court notes this
conclusion is consistent with the other Federal Courts decisions on the ownership of the
stock for other Derivium transactions. See, e.g., Clark v. United States, 2012 WL
6709624, at *7 (N.D. Cal. 2012); Kurata v. Comm’r, T.C.M. 2011-64, 2011 WL 31939344,
at *3 (2011); Shao v. Comm’r, T.C.M. 2010-189, 2010 WL 3377501, at *6 (2010).
Plaintiffs, however, point to the decision of Landow v. Commissioner, 12 T.C. 88,
2011 WL 3055224 (2011), to argue “the Tax Court held that the shares transferred to
Derivium were to be taxed as being constructively sold at the date of transfer, instead of
being taxed on the date of actual sale by Derivium.” Plaintiffs cite to the following portion
of the Tax Court decision in Landow:
We turn now to petitioners’ argument that if we were to find, as we have,
that the Derivium transaction at issue here constitutes a sale by Mr. Landow
of the FRNs [floating rate notes], they would not be required under section
1042(e) to recognize any gain that Mr. Landow realized as a result of that
sale. That is because, according to petitioners, gain under that section is
recognized only where the taxpayer disposes of qualified replacement
property (i.e., the FRN portfolio), and Mr. Landow did not dispose of the
FRN portfolio; Derivium did.
Petitioners’ argument misreads our Opinion in Calloway v. Commissioner,
135 T.C. 26, 2010 WL 2697300 (2010). In Calloway, an important fact was
that Derivium sold the taxpayer’s stock immediately after the taxpayer
transferred it to Derivium. Id. at 34–36, 38–39. That fact, combined with
other facts, led us to hold in Calloway that the taxpayer sold his stock when
he transferred it to Derivium. Id. at 39. We did not hold in Calloway, as
petitioners suggest, that Derivium’s immediate sale of the taxpayer’s stock
constituted the sale with respect to which the taxpayer was subject to tax.
Id. In making their argument under section 1042(e), petitioners are focusing
on the wrong transaction, namely, Bancroft's immediate sale of the FRNs.
The transaction on which we must focus to address petitioners' argument
under section 1042(e) is Mr. Landow’s disposition by sale of the FRNs to
Bancroft.
On the record before us, we have found that Mr. Landow sold the FRN
portfolio when he transferred that portfolio to Bancroft pursuant to the
Derivium transaction documents. On that record, we further find that
70
petitioners are required under section 1042(e) to recognize for their taxable
year 2003 any gain that Mr. Landow realized as a result of that sale.
Landow v. Comm’r, 2011 WL 3055224, at *18. The court disagrees with plaintiffs’
interpretation of Landow that the Landow case concluded there was a constructive sale.56
The Landow court never uses the phrase “constructive sale,” nor does it cite to 26 U.S.C.
§ 1259. Moreover, the Landow court was considering a sale in the context of 26 U.S.C.
§ 1042(e), not 26 U.S.C. § 1259. The provision of the Tax Code at 26 U.S.C. § 1042
addresses “Sales of stock to employee stock ownership plans or certain cooperatives,”
and 26 U.S.C. § 1042(e), specifically deals with “Recapture of gain on disposition of
qualified replacement property,” neither of which are applicable to the above captioned
cases.
In addition, the use of the Landow decision by plaintiffs in the context of a
constructive sale undermines their argument for theft, as immediately after the portion of
the opinion cited by plaintiffs, the Landow court determined:
Petitioners also argue that if we were to find, as we have, that the Derivium
transaction constitutes a sale by Mr. Landow of the FRNs, that sale would
constitute a theft and therefore an involuntary conversion under section
1033(a). Consequently, according to petitioners, they are entitled to
purchase replacement property as required by section 1033(a)(2)(A) and
thereby defer under section 1033(a) any gain that Mr. Landow realized as
a result of that sale.
In Wheeler v. Commissioner, 58 T.C. 459, 1972 WL 2577 (1972), we
explained the scope and the purpose of section 1033 as follows:
Congress clearly intended to extend the benefits of section
1033 * * * only to public takings and casualty-like conversions,
and the limitation of its benefits to involuntary conversions-i.e.,
those “wholly beyond the control of the one whose property
has been taken”-reflects that intent.
Id. at 463 (quoting Dear Publ. & Radio, Inc. v. Commissioner, 274 F.2d 656,
660 (3d Cir.1960), affg. 31 T.C. 1168, 1959 WL 1281 (1959)).
Mr. Landow voluntarily entered into the Derivium transaction in which he
transferred to Bancroft the FRN portfolio in exchange for $13.5 million in
cash and gave Bancroft the right, inter alia, to sell the FRN portfolio without
notice to him and to retain the proceeds of that sale. On the record before
us, we find that Mr. Landow’s sale of the FRN portfolio to Bancroft in
56The court also notes one of the differences between Landow and the above captioned
cases is that the securities transferred to Derivium were stocks by plaintiffs and the
securities transferred by Landow were floating rate notes.
71
exchange for $13.5 million in cash does not constitute an involuntary
conversion, as defined in section 1033. On that record, we further find that
petitioners are not entitled to defer under that section any gain that Mr.
Landow realized as a result of that sale.
Landow v. Comm’r, 2011 WL 3055224, at *18-19 (footnote omitted).
In addition to Calloway, as noted by defendant, in United States of v. Cathcart, the
United States District Court for the Northern District of California issued an unpublished
decision on an interim motion for summary judgment and concluded:
The government has established, through reliance on legal precedent and
the undisputed evidence in the record, that the 90% loan transactions at
issue constitute sales of securities for purposes of tax code treatment, as
opposed to bona fide loans. The undisputed evidence reveals, among other
facts: that, as part of the loan transaction in question, legal title of a
customer’s securities transfers to Derivium (for example) during the
purported loan term in question, which vests possession of the shares in
Derivium’s hands for the duration of the purported loan term; that the
customer must transfer 100% of all shares of securities to Derivium and that
once transferred, Derivium sells those shares on the open market, and that
once sold, Derivium transfers 90% of that sale amount to the customer as
the “loan” amount, keeping 10% in Derivium’s hands; that during the term
of the loan, the Master Loan Agreement provides that Derivium has the right
to receive all benefits that come from disposition of the customer’s
securities, and that the customer is not entitled to these benefits; that the
customer is furthermore prohibited from repaying the loan amount prior to
maturity and is not required to pay any interest before the loan maturity date;
and that, at the end of the purported loan term, the customer is not required
to repay the amount of the loan (but merely allowed to do so as one option
at the loan’s maturity date) and can exercise the option to walk away from
the loan entirely at the maturity date without repaying the principle; and thus,
can conceivably walk away from the transaction without paying interest at
all on the loan.
United States of Am. v. Cathcart et. al, No. C 07–4762 PJH, 2009 WL 3103652, at *1
(N.D. Cal. Sept. 22, 2009).57
Plaintiffs respond notwithstanding the forgoing, that this court should treat the
Derivium transaction as a constructive sale for a forward contract. The constructive sale
57 As noted above that the stipulations in the above captioned cases, even though
organized differently are identical to the United States of America’s Proposed Findings of
Fact and Conclusions of Law in United States of America v. Charles Cathcart, et al., N.D.
Cal., Case No: C-07-4762 PJH.
72
provision of the Tax Code allows for “a futures or forward contract to deliver the same or
substantially identical property.” 26 U.S.C. § 1259(c)(1)(C). Plaintiffs contend that
[i]n this case, the 90% stock loan was a constructive sale because the
Plaintiffs entered into forward contracts with Derivium. The collateral stocks
were appreciated financial positions because if sold there would be gain.
The contracts were forward contracts because the Plaintiffs agreed to
deliver a fixed number of shares in three years in exchange for a fixed price
of 90% of their initial value. Derivium was to provide hedging services and
was required to act as custodian of the collateral during that time.
(internal citations omitted). The court notes, however, that there was no contract that
plaintiffs entered into for future results. Plaintiffs could repay the loan amount or surrender
their interests, but they were not obligated to provide anything to Derivium under the terms
of the loans. Additionally the court cannot find a constructive sale when the plaintiffs in
the cases before this court all selected the option to surrender the stock to Derivium at
the end of the loan period. Defendant also points out that because ownership had been
transferred to Derivium at the beginning of the loan period, “the Agreement cannot be
treated as a forward contract since plaintiffs were not obligated ‘to deliver the same or
substantially identical property’ to Derivium at the end of the three years.” (quoting 26
U.S.C. § 1259(c)(1)(c).
In addition, defendant stresses that 26 U.S.C. § 1259 “cannot apply because
plaintiffs did not recognize any gain when they transferred their stocks, but rather treated
the 90% payment as a nontaxable loan.” Plaintiffs respond that
[a]lthough Plaintiffs were not aware what had transpired, nor were they
certain as to how the 90% loan should have been reported, they filed tax
returns that self-reported their best estimate based on independent legal
advice. At the end of the loan terms Rochlis, Warren, and Ishii reported
capital gains tax on the cash received from Derivium, plus dividends
reported on stocks that Derivium previously sold, plus three years of
interested [sic] reported by Derivium which they had previously deducted
based on financial reports issued by Derivium.
Although the court is sympathetic to plaintiffs’ apparent reliance on counsel, and
Derivium’s false representations to plaintiffs, this does not change the facts, as indicated
above, that plaintiffs reported on their 2002 and 2003 tax returns that their stocks had
been sold when they surrendered the stocks to Derivium. In addition, to reporting having
entered into sales, the plaintiffs also reported the principal and interest on the sale of the
stocks in the same tax years. Therefore, the plaintiffs have not demonstrated that their
Derivium transactions were constructive sales. For the foregoing reasons, the court finds
that the plaintiffs have not met their burden under Massachusetts law and Connecticut
law and 28 U.S.C. § 165 of a theft loss.
73
CONCLUSION
After a review of the record, the trial transcript, the submissions of the parties, and
the applicable law, the court concludes that for the reasons discussed above, none of the
plaintiffs qualify for a theft loss for their 2009 tax years. Therefore, plaintiffs are not entitled
to a theft loss deduction under 26 U.S.C. § 165. Plaintiffs’ complaints are DISMISSED.
The Clerk of the Court shall enter JUDGMENT consistent with this Opinion.
IT IS SO ORDERED.
s/Marian Blank Horn
MARIAN BLANK HORN
Judge
74