09-3583-cv

United States Court of Appeals for the

Second Circuit

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

STEVEN BYERS, WEXTRUST CAPITAL, LLC, WEXTRUST EQUITY PARTNERS, LLC, WEXTRUST DEVELOPMENT GROUP, LLC,

WEXTRUST SECURITIES, LLC, AXELA HOSPITALITY, LLC, ELKA SHERESHEVSKY,

Defendants,

JOSEPH SHERESHEVSKY,

Third-Party-Plaintiff,

AVROHOM SHERESHEVSKY, HOLMES REVOCABLE TRUST,

Intervenors-Defendants,

(For Continuation of Caption See Inside Cover) _______________________________

ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK

BRIEF AND SPECIAL APPENDIX FOR CLAIMANT-APPELLANT MARTIN MALEK

THOMAS, ALEXANDER

& FORRESTER LLP Attorneys for Claimant-Appellant

Martin Malek 14 27th Avenue Venice, California 90291 (310) 961-2536

TIMOTHY J. COLEMAN,

Receiver-Appellee,

– v. –

MARTIN MALEK,

Claimant-Appellant,

SPACE PARK ISSB PARTNERSHIP,

Interested-Party,

TCF NATIONAL BANK, REGIONS BANK,

Movant-Appellant,

SPACE PARK AIM PARTNERSHIP,

Movant,

AMNON COHEN,

Third-Party-Defendant.

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TABLE OF CONTENTS Page PRELIMINARY STATEMENT ..........................................................................1

JURISDICTIONAL STATEMENT.....................................................................5

I. DISTRICT COURT AND APPELLATE JURISDICTION ....................................5

II. TIMELINESS AND FINALITY ........................................................................6

ISSUES PRESENTED ...........................................................................................6

STATEMENT OF THE CASE.............................................................................7

STATEMENT OF THE FACTS ..........................................................................7

I. THE WEXTRUST DEFENDANTS’ REAL ESTATE BUSINESS .........................7

II. APPELLANT’S INVESTMENT: THE “COMMODITY POOLS”........................9

III. THE RECEIVERSHIP AND ASSET FREEZE ORDER .....................................11

IV. THE RECEIVER’S INVESTIGATION ............................................................14

A. The Commodity Pools Were Unaffected By Any Fraud ...................15

B. The Only Meaningful Source of Funds Available to Pay Professional Fees Was the Commodity Pools.............................16

V. THE COMMODITY POOL INVESTORS’ COMPLAINTS ................................18

VI. THE RECEIVER’S DISTRIBUTION PLAN’S IMPROPER DISTRIBUTION OF THE COMMODITY POOL INVESTORS’ ASSETS.....................................19

SUMMARY OF ARGUMENT ............................................................................20

ARGUMENT .........................................................................................................21

I. STANDARD OF REVIEW ..............................................................................21

II. THE DISTRICT COURT CANNOT APPROVE A PLAN TO DISTRIBUTE ASSETS THAT ARE NOT PART OF THE RECEIVERSHIP ESTATE................22

A. The Receiver’s Right to Distribute Assets Is Limited to Assets Owned by the Wextrust Defendants and Their Affiliates..................23

B. The Commodity Pools Are Not Owned by the Wextrust Defendants or Their Affiliates............................................................24

C. None of the Commodity Pools, Their Manager or Investors Were “Wrongdoers” ...........................................................................26

III. THE DISTRICT COURT CANNOT APPROVE A DISTRIBUTION PLAN THAT LIQUIDATES THE RECEIVERSHIP ESTATE .............................28

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A. The Second Circuit Has Repeatedly Held that District Courts Are Not To Liquidate Assets in a Receivership.................................29

B. The SEC and the Receiver Are Not Permitted to Seek Liquidation.................................................................................30

C. The District Court Incorrectly Dismissed the Second Circuit’s Holdings in Eberhard and American Board of Trade........................32

1. Credit Bancorp I Did Not Overrule the Holdings in Eberhard and American Board of Trade....................................33

2. Credit Bancorp I Is Distinguishable...........................................34

IV. A “PRO RATA” DISTRIBUTION OF THE RECEIVERSHIP ASSETS IS IMPROPER ..............................................................................................35

A. The Commodity Pool Investors Were Not “Similarly Situated” .......35

1. The Commodity Pool Investments Are Not Similar as a Matter of Law .............................................................................36

2. The Investments in the Commodity Pools Had Vastly Different Levels of Risk and Reward than the Other Wextrust Investments. ......................................................37

3. The Commodity Pool Investors and the Defrauded Investors Did Not Give Control Over Their Assets to the Same Entity.................................................................................39

4. The Commodity Pool Investments Did Not Share a “Reasonably Close Resemblance of Facts and Circumstances” with Other Investments ....................................39

5. The Commodity Pool Investors Had a Different Relationship to the Defendants than the Defrauded Investors....................................................................42

6. The Commodity Pool Investors Did Not Understand Their Investments to Be “Part of a Whole” with the Defrauded Investors....................................................................43

B. The Commodity Pool Funds Were Not “Commingled” ....................44

1. The Activity Between the Funds Was Not “Commingling” ......44

a. No Commingling Occurred in the Commodity Pools ........45

b. The Commodity Pool Funds Made Legitimate Loans to Wextrust Entities..................................................46

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2. These Transactions Are Not Sufficient to Find Commingling In Commodity Pool Funds..........................................................47

a. Minimal, if Any, Commingling Occurred ..........................47

b. The District Court Mistakenly Relied on Cases Involving Far More Commingling than that Present in this Case .............................................................48

C. A Pro Rata Distribution Is Inequitable...............................................49

CONCLUSION......................................................................................................51

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TABLE OF AUTHORITIES

Cases Page(s) Burke v. PriceWaterhouseCoopers LLP Long Term Disability Plan,

572 F.3d 76 (2d Cir. 2009) .................................................................................. 22 CFTC v. Eustace,

No. 05-2973, 2008 WL 471574 (E.D. Pa. Feb. 19, 2008)................. 36, 43, 47, 49 CFTC v. Rolando,

No. 3:08-CV-0064, 2008 WL 5225851 (D. Conn. Dec. 10, 2008) ......... 36, 39, 43 CFTC v. Probber Int'l Equities Corp.,

504 F. Supp. 1154 (S.D.N.Y 1981) ..................................................................... 24 City of Philadelphia v. Lieberman,

112 F.2d 424 (3d Cir. 1940) ...........................................................................49-50 Dirks v. Clayton Brokerage Co. of St. Louis,

105 F.R.D. 125 (D. Minn. 1985) ......................................................................... 25 Eberhard v. Marcu,

530 F.3d 122 (2d Cir. 2008) ..........................................................................passim Esbitt v. Dutch-American Mercantile Corp.,

335 F.2d 131 (2d Cir. 1964) ................................................................................ 23 Fleming v. Lind-Waldock & Co.,

922 F.2d 20 (1st Cir. 1990)............................................................................23, 25 In re San Vicente Medical Partners Ltd.,

962 F.2d 1402 (9th Cir. 1992) ............................................................................. 22

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Lankenau v. Coggeshall & Hicks, 350 F.2d 61 (2d Cir. 1965) .................................................................................. 29

Lizardo v. Denny's, Inc.,

270 F.3d 94 (2d Cir. 2001) .............................................................................36, 40 SEC v. American Board of Trade, Inc.,

830 F.2d 431 (2d Cir. 1987) ..........................................................................passim SEC v. Better Life Club of America, Inc.,

995 F. Supp. 167 (D.D.C. 1998).....................................................................47, 49 SEC v. Black,

163 F.3d 188 (3d Cir. 1998) .......................................................... 22, 27-28, 49-50 SEC v. Byers,

637 F. Supp. 2d 166 (S.D.N.Y. 2009) ...........................................................passim SEC v. Capital Consultants, LLC,

No. 03-35406, 2003 WL 22768030 (9th Cir. Oct. 14, 2003) .............................. 24 SEC v. Cherif,

933 F.2d 403 (7th Cir. 1991) ..........................................................................27-28 SEC v. Credit Bancorp, Ltd.,

290 F.3d 80 (2d Cir. 2002) ............................................................................passim SEC v. Credit Bancorp, Ltd.,

297 F.3d 127 (2d Cir. 2002) ...............................................................................5-6 SEC v. Credit Bancorp, Ltd.,

No. 99 CIV 11395, 2000 WL 1752979 (S.D.N.Y. Nov. 29, 2000)..................... 33 SEC v. Enterprise Trust Co.,

No. 08 C 1260, 2008 WL 4534154 (N.D. Ill. Oct. 7, 2008)...........................36-39

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SEC v. Lauer,

No. 03-80612-Civ, 2009 WL 812719 (S.D. Fla. March 26, 2009) ..................... 48 SEC v. Murphy,

626 F.2d 633 (9th Cir. 1980) ............................................................................... 46 SEC v. Pittsford Capital Income Partners, LLC,

No. 06 Civ 6353, 2007 WL 2455124 (W.D.N.Y. Aug. 23, 2007) ...................... 46 SEC v. Sunwest Mgmt, Inc.,

No. 09-6056, 2009 WL 3245879 (D. Or. Oct. 2, 2009) .................................45-48 United States v. Moore,

27 F.3d 969 (4th Cir. 1994) .................................................................................48 United States v. Real Property Located at 13328 & 13324 State Hwy. 75 North,

89 F.3d 551 (9th Cir. 1996) ............................................................................48-49 United States v. Ward,

197 F.3d 1076 (11th Cir. 1999) ......................................................................47-48 Statutes 7 U.S.C. § 1a .............................................................................................................41 15 U.S.C. § 77v...........................................................................................................5 15 U.S.C. § 78aa .........................................................................................................5 15 U.S.C. § 78u.....................................................................................................5, 27 28 U.S.C. § 1292.........................................................................................................5 17 C.F.R. § 4.10 ........................................................................................................ 50

- vii - 

17 C.F.R. § 4.20 ....................................................................................... 10, 25, 37, 39 Other Authorities 19 Moore’s Federal Practice § 202.08 (3d ed. 1999) ..................................................6 Glossary of terms of the CFTC,

http://www.cftc.gov/educationcenter/glossary/glossary_co.html ........................ 40

1

Appellant Martin Malek appeals the order of the United States District Court

for the Southern District of New York approving a court-appointed receiver’s plan

of distribution of receivership assets (the “Distribution Order”). See Securities &

Exchange Comm’n v. Byers, 637 F. Supp. 2d 166 (S.D.N.Y. 2009).

PRELIMINARY STATEMENT

Receivers are appointed to safeguard the interests of investors in a defrauded

company, to “marshal the assets” of that company and “prevent the dissipation of a

defendant’s assets pending further action of the court.” Securities & Exchange

Comm’n v. American Board of Trade, Inc., 830 F.2d 431, 436 (2d Cir. 1987).

Receivers’ powers are not unlimited, however. They are not appointed to

liquidate companies or to adjudicate the competing claims of creditors—that is

what bankruptcy courts are for. And, given their stated mandate to preserve the

assets of the receivership estate and protect the victims, they are certainly not

appointed to create victims by wrongfully seizing assets belonging to third parties

and seeking, by way of a Distribution Order, to pay their own substantial

professional fees out of those proceeds.

That is precisely what has happened here.

2

The receivership at issue here began with five “Wextrust Defendants,”1

companies organized to purchase real estate properties and manage the real estate

limited liability companies that operated them. On application by the Securities

and Exchange Commission (“SEC”), the District Court appointed a receiver

(“Receiver”), the Appellee, over these five Wextrust Defendants to determine the

extent and nature of a fraud committed by their principals.

The District Court also froze assets “owned or controlled” by the Wextrust

Defendants to give the Receiver an opportunity to determine their “true financial

condition,” and to “prevent further dissipation of the property and assets” of the

defrauded companies. Joint Appendix (“JA”) at A-144 (Order Appointing

Temporary Receiver); JA at A-156–A-158 (Asset Freeze Order).

In the following months, the Receiver’s investigation revealed that the

Wextrust Defendants had next to nothing in the way of assets. After claiming real

property assets of nearly $60 million in “book value” while seeking compensation,

JA at A-829–A-830 (First Fee Application), the Receiver ultimately conceded, due

in part to the massive, global collapse in real estate values, that “there is little, if

1 The “Wextrust Defendants” are Wextrust Capital, LLC, Wextrust Equity Partners, LLC, Wextrust Development Group, LLC, Wextrust Securities, LLC and Axela Hospitality, LLC.

3

any, going concern value in the Wextrust real estate operations.” JA at A-1300, A-

1301 (Distribution Plan); see also JA at A-713 (Sordillo Decl.) (“The majority of

the properties owners by the Wextrust Affiliates generate little or no cash flow.”).

Undaunted, the Receiver looked elsewhere for cash to fund the receivership

estate, and found the assets belonging to Appellant and similarly situated investors:

the “Commodity Pools.” The Commodity Pools invested in by Appellee had not

lost money, had not been involved in the fraud, and had not invested in the

Wextrust Defendants’ doomed real estate ventures, but in mutual fund-type pools

investing in commodities.

The only connection between the Commodity Pools and the Wextrust

Defendants was that an affiliate of one of the Wextrust Defendants—Wextrade

Commodity Managers, LLC (“WCM”)—was a statutory manager of the

Commodity Pools. WCM was not accused of any fraud and the Commodity Pools

were not missing any money. Absent the Receiver seizing funds the Wextrust

Defendants did not own, the Commodity Pool owners would have suffered no

losses at all.

Although investors in the Commodity Pools (the “Commodity Pool

Investors”) repeatedly argued these points to the Receiver, their arguments fell on

deaf ears for obvious reasons. The Receiver had accumulated approximately $23

4

million on behalf of the receivership, at least $17.6 million of which came not from

the fraudulent enterprises owned and managed by the Wextrust Defendants, but

from the Commodity Pools. JA at A-828 n.7 (First Fee Application). The

remaining $5.4 million legitimately recovered from the fraudulent Wextrust

Defendants is less than the $6 million the Receiver and his law firm have already

collected in fees and less than half of the $12 million the Receiver expects to

charge in professional fees by the end of this year! JA at A-828, A-1824.

Notwithstanding these objections and Appellant’s ongoing efforts to have

his property returned, the Receiver sought confirmation of a plan (the “Plan”) to

pay the balance of “administrative fees” and then distribute what remained of the

Wextrust Defendants’ receivership estate—including what remains of the

Commodity Pool assets—on a pro rata basis.

The Plan is flawed and should not have been confirmed by the District Court

on several legal grounds, including that it is actually a plan of liquidation,

exceeding the intended authority of the Receiver, and that it wrongfully

contemplates a pro rata distribution of assets among investors who are not

“similarly situated”—real estate speculators whose investments tanked and

Commodity Pool investors whose funds did not—and whose assets were not

commingled with those of actually defrauded investors.

5

More fundamentally, however, the Plan contemplates the distribution of

assets that do not belong to the receivership estate, assets preliminarily frozen by

the District Court and then, with no analysis or objective consideration,

inexplicably included in a liquidation plan for the benefit of unrelated investors

and for the Receiver himself. No plan can properly achieve this end. For these,

and the following reasons, the Distribution Order approving the Receiver’s Plan

should be reversed, and the Commodity Pool assets released to their rightful

owners.

JURISDICTIONAL STATEMENT

I. DISTRICT COURT AND APPELLATE JURISDICTION

The District Court had jurisdiction over this action pursuant to Section 22(a)

of the Securities Act, 15 U.S.C. §77v(a), and Sections 21(e) and 27 of the

Exchange Act, 15 U.S.C. §§78u(e) and 78aa. This Court has jurisdiction under 28

U.S.C. §1292(a)(1) since the District Court ruling modified an injunction freezing

Appellant’s assets. Interlocutory orders of the district courts modifying injunctions

are appealable. SEC v. Credit Bancorp, Ltd., 290 F.3d 80, 86-87 (2d Cir. 2002)

(“Credit Bancorp I”); SEC v. Credit Bancorp, Ltd., 297 F.3d 127, 136 (2d Cir.

2002) (“Credit Bancorp II”).

6

II. TIMELINESS AND FINALITY

The Receiver filed his Plan with the District Court on March 27, 2009 and

the District Court approved it on July 23, 2009. JA at A-1293–A-1339; Special

Appendix (“SPA”) at SPA-1–SPA-44. Appellant filed a timely Notice of Appeal

on August 20, 2009. JA at A-1763. The approval of a distribution plan (i.e., the

“Distribution Order”) in an SEC action is deemed a “final order” of a United States

District Court. Credit Bancorp II, 297 F.3d at 136 (citing Credit Bancorp I, 290

F.3d at 82 and 19 Moore’s Federal Practice § 202.08, at 202-32 (3d ed.1999)).

ISSUES PRESENTED

1. Did the District Court err as a matter of law when it approved a plan

of distribution that improperly included Commodity Pool assets in the

receivership?

2. Did the District Court err as a matter of law by approving a plan of

distribution that liquidates the receivership estate?

3. Did the District Court abuse its discretion when it found that the

Commodity Pool Investors were “similarly situated” to investors in the Wextrust

Defendants and that commingling among the Commodity Pools and the assets of

the Wextrust Defendants was sufficient to justify pro rata distribution of the

receivership assets?

7

STATEMENT OF THE CASE

This case is an appeal of the District Court’s order approving a plan of

distribution for a receivership, the “Distribution Order.” The Receiver moved for

approval of his Plan on March 27, 2009, and proposed to include Appellant’s

assets among the distributions. Appellant (and other similarly situated investors)

objected to the Receiver’s Plan. On May 21, 2009, the District Court heard

argument on their objections. On July 23, 2009, the District Court entered the

Distribution Order approving the Receiver’s Plan. SPA at SPA-1–SPA-44. On

August 20, 2009, Martin Malek timely filed his Notice of Appeal. JA at A-1763.

STATEMENT OF FACTS

I. THE WEXTRUST DEFENDANTS’ REAL ESTATE BUSINESS

Wextrust Capital, LLC was formed in 2003 “with the business purpose to

find investment opportunities, mainly in undervalued real estate assets.” JA at A-

115 (SEC Complaint). Together with the other four Wextrust Defendants,

Wextrust Capital, LLC “solicit[ed] investors . . . and manage[d] the offerings and

investments relating to the purchase of real estate” and real estate-based assets

rights to “diamond mining interests in Africa.” Id.; see also JA at A-252–A-253.

The Wextrust Defendants raised money through the sale of membership

interests in limited liability companies (“LLCs”). The LLCs were to be ownership

8

vehicles for real estate interests such as hotels, commercial offices, residential real

estate, or mining or other land rights. JA at A-115–A-116, A-252–A-253. A

Wextrust Defendant or its affiliate was designated to manage each of the LLCs.

A Wextrust Defendant or an affiliate typically had a membership interest

(i.e., an ownership interest) in an LLC that owned real estate. JA at A-729 (First

Interim Report). In a typical example, a Wextrust Defendant owned a controlling

60% interest of the entity owning the real property and sold to investors its interest

in the remaining 40%. Mar. 18, 2009 Radke Decl. (Dkt. No. 226), Ex. B at 9.

Thus, each real property (and the LLC owning it) was an asset owned and

controlled by a Wextrust Defendant or its affiliate.

The offering documents for the investments in these LLCs represented that

“the proceeds raised from the investors, together with a mortgage loan, will be

used to purchase and operate a specific commercial real estate property.” See JA at

A-116 (SEC Complaint). According to the SEC, however, the Wextrust

Defendants were not using the proceeds of its offerings to purchase and operate

their real estate operations, but to operate a massive ponzi scheme. According to

the SEC, the Wextrust Defendants’ principals had defrauded investors in the real

estate companies, including by “raising money in the various offerings . . . to make

9

unauthorized payments to fund the operations of the Wextrust Entities.” JA at A-

107.

II. APPELLANT’S INVESTMENT: THE “COMMODITY POOLS”

Unrelated to the real estate operations of the Wextrust Defendants were the

operations of four “commodity pool” funds (i.e. the “Commodity Pools”) in which

the Appellant (and other Commodity Pool Investors) invested.2 The Commodity

Pools were vehicles for investors to trade in commodity futures, including energy,

metals, grains and meats, United States currency and foreign exchange, interest

rate related products and global equity indices. JA at A-1071; see also JA at A-

758–A-759 (First Interim Report); JA at A-1005–A-1059 (Commodity Pool

PPMs). The Commodity Pools attracted approximately $17 million in investment.

JA at A-758 (First Interim Report); JA at A-1070.

The only nexus between the Commodity Pools and the Wextrust Defendants

is that an affiliate of the Wextrust Defendants, WCM, acted as the statutory

manager of the Commodity Pools. JA at A-1071. Significantly, the Commodity

2 The four Commodity Pools are WexTrade Diversified Futures Fund I, LLC, WexTrade Diversified Offshore Futures Fund I, Ltd., WexTrade Principal Protected Fund I, LLC, and WexTrade Principal Offshore Fund I, Ltd.

10

Pool investments were different from the Wextrust Defendant real estate

investments in at least three respects:

First, the Commodity Pools were not owned, in whole or in part, by any

Wextrust Defendant or affiliate. By law, the investors in the Commodity Pools

retained exclusive ownership of the assets in the Commodity Pools. Commodity

pools and their managers are strictly regulated and consistent with those

regulations, neither WCM nor any of the Wextrust Defendants could or did have

any ownership interest in the Commodity Pools. Unlike the real estate LLCs, in

which the Wextrust Defendants typically retained 60% ownership interest, Mar.

18, 2009 Radke Decl. (Dkt. No. 226), Ex. B at 9, the funds in those Pools were

never assets of the Wextrust Defendants.

Second, the Commodity Pools did not lose any money from fraud.

Consistent with the requirement that their funds be kept segregated at all times, see

17 C.F.R. § 4.20(a)(1), (c), the Commodity Pool funds were unaffected by frauds

in the Wextrust Defendants’ real estate business. See JA at A-1340. Until the

Receiver withdrew funds for operation of the receivership estate, the monies

invested by Appellant and other Commodity Pool Investors had lost no money to

the frauds of the Wextrust Defendants. Id. Further, the Commodity Pool manager,

WCM, was not named as a Wextrust Defendant, nor was Paul Adrian, WCM’s

11

former principal who was responsible for the day-to-day operations of WCM. JA

at A-106. The Commodity Pools were not victimized by fraud.

Third, the Commodity Pools were not invested in real estate. Unlike the

investments offered by the Wextrust Defendants, the Commodity Pools were

invested in commodities. See JA at A-758–A-759, A-1070–A-1071, A-1340.

Investors in these pools were not tied to risks associated with real property, which

risks materialized in the form of a broad, worldwide collapse in real estate markets.

While the Wextrust Defendants’ assets were substantially depressed by this drop in

value, the Commodity Pools were unaffected.

By the time of the creation of the receivership, the Commodity Pools held

approximately $17.6 million of Malek’s and the Commodity Pool Investors’

money. JA at A-828 n.7.

III. THE RECEIVERSHIP AND ASSET FREEZE ORDER

The paths of the Commodity Pools and the Wextrust Defendants crossed on

August 11, 2008.

On August 11, 2008, the SEC filed its complaint against the five Wextrust

Defendants and their two principals, alleging that money raised for real estate

investment was actually used to fund the Wextrust Defendants’ operations. JA at

A-106–A-142 (SEC Complaint). According to the SEC, for example, the Wextrust

12

Defendants raised $9 million in private placements “to purchase and operate seven

commercial properties” leased to the General Services Administration, which they

did not do, see JA at A-117, A-119 (SEC Complaint); raised $9.3 million in

investments in a real estate LLC formed to a acquire and operate a Crowne Plaza

hotel in Arizona, which was instead used to fund operations of the Wextrust

Defendants, JA at A-120–A-123; and raised $4 nearly million to acquire an interest

in an African company that “own[ed] the exploration and mining rights in a group

of diamond mines,” which it never acquired, JA at A-123–A-124.

According to the SEC, the millions of dollars raised to purchase and manage

office buildings, hotels, and residential properties were instead diverted to the

Wextrust Defendants. More specifically, the proceeds of these offerings were used

by the Wextrust Defendants as part of a ponzi scheme “to pay prior investors in

unrelated offerings and to make unauthorized payments to fund the operations of

the Wextrust [Defendants].” JA at A-107 (SEC Complaint).

Based on its complaint, the SEC also requested the appointment of a receiver

over the Wextrust Defendants to “preserve the status quo” while managing the

Wextrust Defendants, prevent any dissipation of the assets that would ultimately be

returned to “victims,” bring the Wextrust Defendants into compliance with the law,

and, if necessary, to “place [the] hopelessly insolvent entities in bankruptcy to

13

effect their liquidation.” JA at A-197–A-198 (SEC Memorandum in Support of

Application for Emergency Relief).

The District Court granted the SEC’s request on that same day and named

Appellee as the Receiver of the Wextrust Defendants. It its order, JA at A-143–A-

147 (“Receiver Order”), the District Court assigned the Receiver broad

management rights over the Wextrust Defendants and was specifically charged

with “determin[ing] whether the [Wextrust Defendants] should undertake

bankruptcy filings.” JA at A-144; see also JA at A-145.

Also on the same day, and again on application of the SEC, the District

Court issued an order freezing the assets of the Wextrust Defendants (i.e., the

“Asset Freeze Order”). The Asset Freeze Order compelled a host of persons to

“hold and retain . . . and otherwise prevent . . . disposal of any assets . . . of, held

by, or under the direct or indirect control of the Defendants.” JA at A-157. The

Asset Freeze Order also sought to freeze assets of entities associated or affiliated

with the Wextrust Entities or entities under their control including “those entities

listed in Exhibit A.” Id. Because they were managed by WCM, Exhibit A

included the Commodity Pools.

The Asset Freeze Order worked in conjunction with the Receiver Order,

which authorized the Receiver to take “immediate possession and control of all of

14

the assets and the property of the [Wextrust Defendants] and all entities they

control or in which they have an ownership interest including, but not limited to,

those entities listed on Exhibit A,” JA at A-145 (Receiver Order), to serve the

SEC’s and the District Court’s stated goal of “preserving the status quo.” JA at A-

144. Between the Receiver’s taking control of these assets and all persons

receiving the Asset Freeze Order being directed to maintain them, the Receiver

(and the SEC) would be permitted time to investigate the fraud at the Wextrust

Defendants, determine the nature and extent of the fraud, and make a decision as to

whether the defendant entities should be put into bankruptcy.

Consistent with the Asset Freeze Order, the Receiver froze the assets in the

Commodity Pools, transferred them to their own fiduciary account and

discontinued the commodities trading associated with the accounts. JA at A-1071,

A-1340, A-1465. By this time, the $17 million originally invested in the

Commodity Pools had grown to $17.6 million. JA at A-828 n.7, A-1070. The

Receiver’s transfer was consistent with the Asset Freeze Order directing the

Receiver to “preserve the status quo” pending its investigation.

IV. THE RECEIVER’S INVESTIGATION

Over the next seven months, in addition to “marshal[ing] the assets of the

receivership estate,” the Receiver managed and investigated the financial condition

15

of the Wextrust Defendants. JA at A-1299 (Distribution Plan). With respect to the

Commodity Pools, his investigation yielded two immutable conclusions. First, that

the Commodity Pools were unaffected by any fraud; and second, that the $17.6

million from the Commodity Pools were the only meaningful source of funds

available to pay the professional fees of the Receiver and his firm.

A. The Commodity Pools Were Unaffected By Any Fraud

No one expected the Commodity Pools—or any person investing, owning or

managing them—to have been involved in the Wextrust Defendants’ fraud.

Nowhere in the SEC’s complaint is there any reference to the Commodity Pools,

nor any reference to their manager, WCM. JA at A-106–A-142 (SEC Complaint).

Paul Adrian, the person responsible for managing on WCM’s behalf, is not

mentioned in the SEC’s complaint and is not alleged to have played any part in the

fraud. Id. No investor in the Commodity Pools is alleged to have been a victim of

the fraud.

The Receiver’s investigation found no differently. Over the course of five

interim reports, the Receiver nowhere mentions any criminal activity resulting in a

loss among any of the Commodity Pools. See JA at A-717–A-820, A-1157–A-

1203, A-1440–A-1486, A-1715–A-1753, A-1916–A-1948 (Five Interim Reports).

The SEC likewise turned up no wrongdoing in any subsequent filing in the case.

16

B. The Only Meaningful Source of Funds Available to Pay Professional Fees Was the Commodity Pools

Consistent with the Receiver’s findings that there was no fraud perpetrated

on investors in the Commodity Pools, the Receiver did not initially count the

Commodity Pools among the assets of the Wextrust Defendants. JA at A-759–A-

774 (First Interim Report).

Indeed, in his First Interim Report (JA at A-717–A-820), the Receiver’s 16-

page description of the “Wextrust Assets” included no mention of the Commodity

Pools. JA at A-759–A-774. Instead, the Receiver’s “descri[ption of] the properties

and assets that are currently owned or controlled by Wextrust Entities or Wextrust

Affiliates” focused exclusively on the real estate assets, the real estate-related

diamond mining assets, and certain “high yield” real estate loans secured by real

estate. JA at A-760. The Commodity Pools were nowhere described as Wextrust

Defendant assets.

Subsequent reports likewise never included the Commodity Pools as

“assets.” Instead, the Receiver only obliquely and occasionally referred to the

“management” of funds like the Commodity Pools, namely that he had

“consolidat[ed] those accounts at a single financial institution in order to minimize

the transaction costs, administrative burden, and risk of errors associated with

17

maintaining a large number of accounts and depositories.” See, e.g., JA at A-1169

(Second Interim Report). In contrast, the Receiver detailed at length the

“management” of a host of the Wextrust Defendants’ real estate properties,

preparations for sale, and collections of rents. JA at A-1162–A-1165.

Notwithstanding that the Commodity Pools were nowhere described as—let

alone demonstrated to be—“Wextrust Defendant” assets, by November 14, 2008

the Receiver nonetheless claimed to have collected approximately $23 million on

behalf of the receivership. JA at A-828 (First Fee Application). Because there was

“little, if any, going concern value in the Wextrust real estate operations,” JA at A-

1300 (Distribution Plan), however, and the real estate assets’ “market value … had

fallen substantially below the amount of debt secured by the properties,” $17.6

million came not from the defrauded entities including the Wextrust Defendants,

but from the Commodity Pools. JA at A-828 n.7, A-1720.

The reason for the Receiver’s blithe inclusion of these amounts as “part of

the receivership” is plain. In the first four and a half months of his receivership,

the Receiver and his law firm had billed for and received more than $6 million

dollars in professional fees. JA at A-1883–A-1888; see also JA at A-1824.

Through the approval of his plan in July 2009, the Receiver expected to be paid

another $4 million dollars. JA at A-1824. By the time he files a responsive brief

18

in this appeal, he anticipates incurring another $2 million in fees for a total of more

than $12 million. Id. As the District Court recognized, the only liquid source of

funds to pay those fees is the Commodity Pool assets.

V. THE COMMODITY POOL INVESTORS’ COMPLAINTS

Shortly after the Asset Freeze Order was entered on August 11, 2008, the

Commodity Pool Investors informed the Receiver that their assets had been

improperly included in the receivership estate and requested their release. JA at A-

908–A-910 (Mot. to Intervene). The Commodity Pool Investors first notified the

Receiver via letter on August 28, 2008 and then subsequently—and repeatedly—

tried to explain their position to the Receiver in person, on the telephone, in

subsequent letters and by email. JA at A-909–A-910.

When the Receiver did not release the assets as requested, the Commodity

Pool Investors believed that the Receiver was temporarily passing them over while

he unraveled the web of issues related to the Wextrust Defendants. JA at A-909.

Instead, on November 14, 2008, the Commodity Pool Investors learned that

their attempts to explain their unique situation to the Receiver had been ignored

entirely. JA at A-821–A-852 (First Fee Application). On that date, the Receiver’s

First Joint Monthly Application for Allowance of Compensation and

Reimbursement of Expenses sought payment for $2.2 million in fees to be paid

19

from the $17.6 million rightfully belonging to the Commodity Pool Investors. JA

at A-822, A-828 n.7.

VI. THE RECEIVER’S DISTRIBUTION PLAN’S IMPROPER DISTRIBUTION OF THE COMMODITY POOL INVESTORS’ ASSETS

Many fee applications later, the Receiver moved for approval of a plan to

liquidate the Wextrust Defendants (i.e., the “Plan”).

Under the Plan, the Receiver intends to make an immediate distribution to

creditors and investors from the cash assets of the receivership estate—assets

which come in large part from the Commodity Pools. JA at A-1299; see also

Byers, 637 F. Supp. 2d at 171; SPA at SPA-9. The distribution of assets under the

Plan will be a complete liquidation of the receivership assets. Byers, 637 F. Supp.

2d at 171; SPA at SPA-9.

The receivership’s remaining assets would be distributed pro rata and each

investor—including Malek and the Commodity Pool Investors—would receive a

distribution based on its percentage of the total amount originally invested in all

Wextrust Defendants or affiliate enterprises. The Plan does not differentiate

between investors. The Receiver estimates investors will receive somewhere

between 5 cents and 50 cents on the dollar.” See JA at A-1523 (May 21, 2009 Tr.);

Byers, 637 F. Supp. 2d at 169; SPA at SPA-4.

20

The Receiver conclusorily stated that a “pro rata distribution is the most

equitable approach in the circumstances of this case.” JA at A-1305. Over the

Appellant’s objection, see JA at A-1340–A-1341, A-1342–A-1363, A-1586–A-

1592, the District Court agreed and approved the Plan by Distribution Order dated

July 23, 2009. SPA at SPA-1–SPA-44. This appeal followed.

SUMMARY OF ARGUMENT

First, the Commodity Pool assets are not part of the receivership estate. The

Receiver’s right to distribute assets is limited to those assets owned by the

Wextrust Defendants and their affiliates. WCM, the manager of the Commodity

Pools and an affiliate of a Wextrust Defendant, was not permitted—and in fact did

not—own any part of the Commodity Pools. Because the Commodity Pool

Investors and WCM were not accused of any wrongdoing, the District Court erred

when it found that the Commodity Pool assets could be included in the

receivership estate.

Second, a district court cannot approve a distribution plan that liquidates a

receivership estate. Since the Receiver’s Plan is a liquidation—as the District

Court acknowledged—this matter should have been transferred to bankruptcy

court, which has the resources and experience to effect a liquidation plan. The

District Court erred when it found—contrary to Second Circuit law—that it could

21

approve a liquidation plan, and the Receiver and SEC contravened Second Circuit

law in even seeking its approval in the first instance.

Third, the pro rata distribution of the receivership assets proposed by the

Receiver was improper and unjust under the circumstances of this case. The

Commodity Pool Investors had completely different investments than the other

investors—the Commodity Pool investments were different as a matter of law and

had vastly different levels of risk and reward than the real estate investments, the

Commodity Pool investors did not give control over their assets to the same

entities and were not “part of a whole” or “share a common fate” with the other

investors, and the Commodity Pool Investors’ assets were not commingled like

those of the other investors. For all of these reasons, the District Court abused its

discretion when it approved the Receiver’s plan to distribute the receivership assets

on a pro rata basis.  

ARGUMENT

I. STANDARD OF REVIEW

This Court conducts a de novo review of the District Court’s approval of a

plan that includes the Commodity Pool assets as part of the receivership estate.

See Credit Bancorp I, 290 F.3d at 87 (applying de novo review of district court’s

22

decision to consider certain securities as part of receivership assets subject to

distribution plan and citing SEC v. Black, 163 F.3d 188, 195 (3d Cir. 1998)).

Similarly, this Court performs a de novo review of the District Court’s

determination that it had the authority to approve a Plan that liquidates the

receivership assets. See Burke v. PriceWaterhouseCoopers LLP Long Term

Disability Plan, 572 F.3d 76, 78 (2d Cir. 2009); In re San Vicente Medical

Partners Ltd., 962 F.2d 1402, 1406 (9th Cir. 1992) (“[L]imits on the district

court’s power to structure a receivership are issues of law, and review is therefore

de novo.”).

This Court reviews the District Court’s approval of the terms of the Plan for

abuse of discretion. Credit Bancorp I, 290 F.3d at 87. Therefore, the District

Court’s finding that a pro rata distribution plan was fair because the Commodity

Pool Investors were “similarly situated” to other investors and because their assets

were commingled is reviewed for abuse of discretion. See, e.g., Credit Bancorp I,

290 F.3d at 88-89.

II. THE DISTRICT COURT CANNOT APPROVE A PLAN TO DISTRIBUTE ASSETS THAT ARE NOT PART OF THE RECEIVERSHIP ESTATE

Consistent with the SEC’s application for his appointment, the Receiver was

not appointed to redistribute property belonging to uninjured third parties to

23

injured investors and to himself, but to “protect those who have already been

injured by a violator’s actions from further despoliation of their property or rights.”

JA at A-197 (SEC Memorandum in Support of Application for Emergency Relief)

(citing Esbitt v. Dutch-American Mercantile Corp., 335 F.2d 131, 143 (2d Cir.

1964)) (emphasis added). Without basis or evident examination of whether the

assets to be liquidated and distributed were properly “marshaled” by the Receiver,

the Plan—wrongfully—does just that and the Distribution Order must be reversed.

A. The Receiver’s Right to Distribute Assets Is Limited to Assets Owned by the Wextrust Defendants and Their Affiliates

Among other duties, the Receiver is charged with “marshal[ing] the assets”

of the defendant, and “prevent[ing] the dissipation of a defendant’s assets pending

further action by the court.” American Board of Trade, 830 F.2d at 436. The

Receiver’s right to marshal assets is to “help preserve the status quo while the

various transactions [are] unraveled.” Id.

The right to marshal assets—and then to distribute those assets—“is not

without limits,” however. Eberhard v. Marcu, 530 F.3d 122, 132 (2d Cir. 2008).

Most fundamentally, the Receiver “stands in the shoes of the corporation” and

therefore “has no greater rights or powers than the corporation itself would have.”

Id. (quoting Fleming v. Lind-Waldock & Co., 922 F.2d 20, 25 (1st Cir. 1990)).

24

As a result, an asset cannot be part of the receivership estate—or a bankrupt

estate—if the asset is not owned by one of the defendants. See Commodity Futures

Trading Comm’n (“CFTC”) v. Probber Int’l Equities Corp., 504 F. Supp. 1154,

1159-60, 1162-63 (S.D.N.Y 1981). The SEC itself has acknowledged this fact:

“[A] receiver has no right to property which does not belong to the entity over

which he was appointed, directly or indirectly.” SEC Brief in SEC v. Capital

Consultants, LLC, No. 03-35406, 2003 WL 22768030, at *15-16 (9th Cir. Oct. 14,

2003).

The reasons for this rule were recognized in Probber, where the district

court found that it would be “unfair and arbitrary” for a creditor’s assets to be

included in the receivership where the asset was not owned by one of the

defendants at the time the receivership began. 504 F. Supp. at 1162-63. The court

likewise found that inclusion of the property in the receivership estate would result

in a “windfall and unjust enrichment” of the other creditors “whose plight … was

attributable to their having placed unwarranted trust” in the defendants. Id.

B. The Commodity Pools Are Not Owned by the Wextrust Defendants or Their Affiliates

The Wextrust Defendants did not own the Commodity Pool assets.

25

By law, the Commodity Pools were wholly separate from WCM, and had no

direct relationship with the Wextrust Defendants. A commodity pool operator like

WCM “must operate its pool as an entity cognizable as a legal entity separate from

that of the pool operator” and may not “commingle the property of any pool that it

operates or that it intends to operate with the property of any other person.” 17

C.F.R. § 4.20(a)(1), (c).

Further, and most critically, WCM, the fraud-free Commodity Pool

manager, was, as a matter of law, not permitted to own any part of the Commodity

Pools. Id. Accordingly, WCM did not own the Commodity Pools, it merely had

the ability to make investment decisions for the Commodity Pools—the

Commodity Pool Investors retained ownership of their assets in the Commodity

Pools. JA at A-1069–A-1071.

Consistent with this statutory scheme, the law has consistently recognized

commodity pools to be the property of individual investors. See, e.g., Dirks v.

Clayton Brokerage Co. of St. Louis, 105 F.R.D. 125, 135 (D. Minn. 1985)

(“[P]ools were not assets of the corporations, but were property of individual

investors.”). Fleming, 922 F.2d at 25 (“[T]he funds allegedly mismanaged by the

[futures commission merchant] in accounts established by [the fraudster] belonged

entirely to investors, not to [the corporation].”).

26

By order of the District Court, the Receiver was appointed to “[t]ake and

retain immediate possession and control of all of the assets and property of the

[Wextrust Defendants] and all entities they control or in which they have an

ownership interest.” JA at A-145 (Receiver Order) (emphasis added). These

assets included the $17.6 million in the Commodity Pools, which was immediately

frozen and forwarded to the Receiver’s designated account. JA at A-1071.

That Order, however, and the possession it permitted was “temporary” and

pending investigation, and the Receiver should have sought the release of any

assets his investigation demonstrated were not the property of the Wextrust

Defendants. Despite the fact that the only evidence is that Commodity Pools were

not the assets of any Wextrust Defendant—in stark contrast to the real estate that is

owned by Wextrust Defendants or their affiliates—the Receiver never sought the

release of the $17.6 million from the receivership estate.

C. None of the Commodity Pools, Their Manager or Investors Were “Wrongdoers”

The only “exception” to the requirement of ownership for inclusion of an

asset in a receivership estate—a “requirement” that has barely required judicial

explication—is where an asset is controlled by a “wrongdoer.” Where a

controlling party has acted wrongfully in a manner that impacts an asset, courts

27

have permitted a receiver consistent with 15 U.S.C. §78u—the statute by which

receivers are given power over the assets of a receivership—to marshal those

assets and determine an equitable plan of return.

In contrast, where there is no proof of wrongdoing, there is no reason to

include non-party assets in a receivership since “[n]othing in the statute or case law

suggests that 15 U.S.C. §78u(d) or (e) authorizes a court to freeze the assets of a

non-party, one against whom no wrongdoing is alleged.” SEC v. Cherif, 933 F.2d

403, 413-14 (7th Cir. 1991); see also Black, 163 F.3d at 196.

Here, passing whether WCM “controlled” the Commodity Pools,3 there has

been no allegation that any of the Commodity Pool Investors were involved in any

of the wrongdoing perpetrated by the Wextrust Defendants. See JA at A-106–A-

142, A-204–A-242 (SEC Complaints); see also JA at A-1340. Moreover, the

Commodity Pool manager, WCM, was not named as a Wextrust Defendant, and

neither was Paul Adrian, WCM’s former principal who was responsible for the

day-to-day operations of WCM.

3 In fact, the Commodity Pool investors retained control over their assets in the Commodity Pools. The Commodity Pools had the ability to fire WCM, the commodity pool operator, with a 75% vote of the members. JA at A-483. Absent court order, the investors could replace WCM in their sole discretion. The ability to dismiss the manager places ultimate control with the investors, not WCM.

28

Without even an allegation that there was wrongdoing in the Commodity

Pools or WCM that depleted those assets, the Receiver has no authority to

permanently seize and then distribute the assets of the Commodity Pools—and pay

his own fees—because these Commodity Pools were not receivership assets.

Black, 163 F.3d at 196; Cherif, 933 F.2d at 413-14.

III. THE DISTRICT COURT CANNOT APPROVE A DISTRIBUTION PLAN THAT LIQUIDATES THE RECEIVERSHIP ESTATE

The Receiver was never intended to liquidate the Wextrust Defendants’

receivership estate. The SEC’s request was for a receiver to investigate and, if

necessary, to “place [the] hopelessly insolvent entities in bankruptcy to effect their

liquidation.” JA at A-197–A-198 (SEC Memorandum in Support of Application

for Emergency Relief). Accordingly, the District Court’s appointment was made

expressly with the understanding that the Receiver would “determine whether the

[Wextrust Defendants] should undertake bankruptcy filings.” JA at A-144; see

also JA at A-145.

Contrary to both the application and the order installing him, the Receiver

proposes to liquidate the assets of the Wextrust Defendants. In so doing, the

Receiver exceeds the intent of the SEC and of the District Court—initially at

29

least—and ignores the repeated counsel of this Second Circuit that liquidation is

the province of bankruptcy courts.

A. The Second Circuit Has Repeatedly Held that District Courts Are Not to Liquidate Assets in a Receivership

The Second Circuit has made clear that district courts are not to liquidate the

assets in a receivership. See Eberhard, 530 F.3d at 132 (“[R]eceivership should

not be used as an alternative to bankruptcy”); American Board of Trade, Inc., 830

F.2d at 436, 438 (“[O]n several other occasions we repeated our view that equity

receiverships should not be used to effect the liquidation of defendants in actions

brought under the securities laws.”); Lankenau v. Coggeshall & Hicks, 350 F.2d

61, 63 (2d Cir. 1965) (“Receiverships ancillary to SEC actions . . . should not be

continued, in a case involving insolvency, beyond the point necessary to get the

estate into the proper forum for liquidation—the bankruptcy court.”).

The reason that the Second Circuit has held that bankruptcy courts are the

proper forum for liquidation is because bankruptcy courts have the necessary

experience and resources to liquidate entities, as well as the guidance of the

bankruptcy code. American Board of Trade, 830 F.2d at 438; Lankenau, 350 F.2d

at 63. District Courts, on the other hand, are not set up to resolve liquidation

proceedings. Id. at 437-38 (noting that “the functions undertaken by the district

30

court in this case demonstrate the wisdom of not using a receivership as a

substitute for bankruptcy”).

Notwithstanding the repeated admonition of this Court, liquidation is exactly

what is being attempted with the Plan in this case. See Byers, 637 F. Supp. 2d at

171 & n.5; SPA at SPA-9. The Plan provides for the distribution of all of the

assets of the receivership, effectively liquidating the all of the Wextrust Defendants

and their affiliates and the Commodity Pools along with them. Id.; JA at A-1293–

A-1339 (Distribution Plan). Indeed, the District Court itself recognized that the

Distribution Plan “is effectively a liquidation.” Byers, 637 F. Supp. 2d at 171 n.5;

SPA at SPA-9. Because a District Court cannot liquidate a receivership, the

Distribution Plan in this case should not have been approved. Eberhard, 530 F.3d

at 132; American Board of Trade, 830 F.2d at 436, 438.

B. The SEC and the Receiver Are Not Permitted to Seek Liquidation

The Plan was approved on application of the Receiver with the assistance

and consent of the SEC. Even the offering of the Plan, however, was in

contravention of this Court’s mandates since the SEC and the Receiver had a

31

responsibility to inform the District Court that it could not embark on a liquidation

of the receivership estate.4 American Board of Trade, 830 F.2d at 438.

The Second Circuit has admonished the SEC that it should not even attempt

liquidations in District Court and that it is the SEC’s burden to bring that fact to the

District Court’s attention:

We now state, however, that in actions of the present kind brought in the future by the SEC, we expect counsel for the agency, as an officer of the court and as part of his or her individual professional responsibility, to bring our views, as stated in this and other decisions, to the attention of the district court before the court embarks on a liquidation through an equity receivership.

American Board of Trade, 830 F.2d at 438.

Moreover, the Receiver was fully aware that its responsibility, if the

Wextrust Defendants were insolvent, was not to prolong its duties as receiver, but

to put the company in bankruptcy. In fact, in its First Fee Application, the

Receiver acknowledged that his charge from the District Court was to “determine

if the Wextrust [Defendants] and Affiliates should undertake a bankruptcy filing.”

JA at A-825. Subsequent fee applications acknowledged the same goal, see JA at

4 The District Court, in fact, also placed this onus on the SEC and the Receiver. In the Order Appointing Temporary Receiver, the District Court charged the Receiver with determining whether the “Wextrust [Defendants] and all entities they control or in which they have an ownership interest should undertake a bankruptcy filing.” JA at A-145 (Receiver Order).

32

A-1208, A-1250, A-1604, A-1672, including a fee application filed just one month

ago. JA at A-1873.

The SEC and the Receiver in this case ignored their responsibilities under

Second Circuit law and the Receiver Order. Rather than informing the District

Court that this case belonged in bankruptcy court, the Receiver presented a Plan

that liquidated the Wextrust Defendants and the Commodity Pools. Byers, 637 F.

Supp. 2d at 171 & n.5; JA at A-1293–A-1339 (Distribution Plan). The SEC and

the Receiver cannot be rewarded for ignoring this Court’s repeated instructions and

the admonitions addressed specifically to them.

C. The District Court Incorrectly Dismissed the Second Circuit’s Holdings in Eberhard and American Board of Trade

Notwithstanding this Court’s clear instructions, the District Court incorrectly

found that it could liquidate the receivership estate in this case.5 Byers, 637 F.

Supp. 2d at 176; SPA at SPA-21. In so holding, the District Court relied on Credit

Bancorp I and dismissed this Court’s holdings in Eberhard and American Board of

Trade. Byers, 637 F. Supp. 2d at 174-76; SPA at SPA-17–SPA-21. That reliance

was misplaced.

5 The District Court did, however, note that it was a “close [decision] that gives me pause.” Byers, 637 F. Supp. 2d at 175; SPA at SPA-19.

33

1. Credit Bancorp I Did Not Overrule the Holdings in Eberhard and American Board of Trade

The District Court, in relying on Credit Bancorp I, held that that case “cast

serious doubt” on the holding of American Board of Trade. Byers, 637 F. Supp. 2d

at 176; SPA at SPA-20. In fact, not only did the Second Circuit not back away

from its warnings in American Board of Trade but it reiterated those warnings in

Eberhard, six years after Credit Bancorp I was decided.

In Credit Bancorp I, Judge Sweet noted the American Board of Trade

“admonition” that “an equity receivership should not be employed as a substitute

for a bankruptcy proceeding to effectuate the liquidation of the defendant firm.”

SEC v. Credit Bancorp, Ltd., No. 99 CIV 11395, 2000 WL 1752979, at *27

(S.D.N.Y. Nov. 29, 2000). Judge Sweet found, however, without diminishing that

holding, that the Credit Bancorp I facts differed because they involved only a

“partial” distribution under the plan and none of the victims wished to initiate

bankruptcy proceedings. Id. at *27-28.

That the Second Circuit did not mean to back away from American Board of

Trade is plain from its recent decision in Eberhard in which—eight years after

Credit Bancorp I was decided—the Court reiterated that receiverships do not have

the power to liquidate estates. Eberhard, 530 F.3d at 132. The District Court

34

acknowledged that it failed to follow the more recent Eberhard in approving the

liquidation of the receivership estate. Byers, 637 F. Supp. 2d at 176 n.11; SPA at

SPA-20. It did so improperly.

2. Credit Bancorp I Is Distinguishable

Neither of the circumstances distinguishing Credit Bancorp I—a partial

liquidation and absence of victims seeking bankruptcy—is present here.

This case involves a total liquidation of the assets of the Wextrust

Defendants and the Commodity Pools. Byers, 637 F. Supp. 2d at 171 & n.5; SPA

at SPA-9; JA at A-1299 (Distribution Plan). It does not involve a partial

distribution but a complete dismantling of a real estate business run aground by

substantial market forces.

In addition, unlike Credit Bancorp I’s creditors, none of whom wished to

initiate bankruptcy proceedings, this case involves creditors who have actively

advocated for it, see Byers, 637 F. Supp. 2d at 176 (noting the position of “a

number of creditors” that the District Court did not have authority to approve a

liquidation plan); SPA at SPA-20, and if fact moved for permission to enter the

Wextrust Defendants into bankruptcy involuntarily. See JA at A-869, A-948–A-

962.

35

IV. A “PRO RATA” DISTRIBUTION OF THE RECEIVERSHIP ASSETS IS IMPROPER

No distribution of the Appellants’ assets is proper because they are not

assets of the receivership. For many of the same reasons, a “pro rata” distribution

to any party investing in any of the Wextrust Defendants’ enterprises—in which

each investor receives “a ratable share of his or her gross investment” regardless of

whether they invested in a fraud or not, JA at A-1305 (Distribution Plan)—is

unjust and improper.

Because, as here, pro rata distributions can create significant inequities

among the investors, in the Second Circuit, pro rata distributions are only

permitted where (1) the investors are “similarly situated” with respect to their

relationship to the defrauders and (2) where commingling has occurred. See Credit

Bancorp I, 290 F.3d at 88-89. Neither condition was met here, and the Plan’s pro

rata distribution is thus improper.

A. The Commodity Pool Investors Were Not “Similarly Situated”

Investors are similarly situated where (a) the investments are similar are as a

matter of law, (b) the investments share a “reasonably close resemblance of facts

and circumstances,” (c) the investments have common levels of risk and reward,

(d) the investors give control over their assets to the same entities, (e) the investors

36

have similar relationships to the defendant, and (f) the investors understand that

they share a common fate. See, e.g., Credit Bancorp I, 290 F.3d at 88-89; Lizardo

v. Denny’s, Inc., 270 F.3d 94, 101 (2d Cir. 2001); CFTC v. Rolando, No. 3:08-CV-

0064, 2008 WL 5225851, at *3-4 (D. Conn. Dec. 10, 2008); SEC v. Enterprise

Trust Co., No. 08 C 1260, 2008 WL 4534154 (N.D. Ill. Oct. 7, 2008); CFTC v.

Eustace, No. 05-2973, 2008 WL 471574, at *8 (E.D. Pa. Feb. 19, 2008).

Far from the “close call” imagined by the District Court, Byers, 637 F. Supp.

2d at 180; SPA at SPA-30, none of these factors suggest the Commodity Pool

Investors were “similarly situated” with the investors in the Wextrust Defendants’

defrauded real estate entities (the “Defrauded Investors.”).

1. The Commodity Pool Investments Are Not Similar as a Matter of Law

The Commodity Pool investments differ from those made by Defrauded

Investors as a matter of law. By law the Commodity Pool assets—assets not of

WCM but of the individual pools themselves—must be separate and distinct from

assets of WCM and separate and distinct from assets of any of the Wextrust

Defendants.

In addition, as a commodity pool Manager WCM “must operate its pool as

an entity cognizable as a legal entity separate from that of the pool operator” and

37

may not “commingle the property of any pool that it operates or that it intends to

operate with the property of any other person.” 17 C.F.R. § 4.20(a)(1), (c). Thus,

WCM, the commodity pool operator, was an entity separate from the Commodity

Pools, each of which was set up as its own entity and maintained accounts in its

own name and WCM had no ownership rights to the Commodity Pool assets.

2. The Investments in the Commodity Pools Had Vastly Different Levels of Risk and Reward than the Other Wextrust Investments.

The investments of the Commodity Pool Investors and the Defrauded

Investors were also distinguishable because the two types of investments had

vastly different levels of risk and reward. Enterprise Trust, 2008 WL 4534154, at

*4-5.

The Commodity Pool Investors chose to enter a highly regulated

investment—a commodity pool—which placed investments in commodities such

as energy and metals. JA at A-1071. In contrast, the Defrauded Investors invested

in real estate, a highly speculative investment disclosed to them to be subject to the

“substantial negative effect” of competitive forces in real estate.6 Mar. 18, 2009

6 WDF Fund and WDOF Fund were marketed as vehicles for speculating in exchange traded futures and options contracts, as well as spot foreign currency markets JA at A-758. The WPP Fund and WPO Fund were marketed as lower-risk

38

Radke Decl. (Dkt. No. 226), Exh. B at 38; see also, e.g., A-1452, A-1720, A-1340.

These differences in risk levels are essential to any comparison among

investors. Enterprise Trust, 2008 WL 4534154, at *4-5. In Enterprise Trust, the

district court approved a distribution plan that acknowledged the different levels of

investor risk associated with the various investments and paid investors based on

those different levels of risk rather than on a pro rata basis. Id. at *2-5. The Court

found that “[t]o regard these two classes of account holders as remotely equal to

each other is inequitable.” Id. at *4-5.

As in Enterprise Trust, the Commodity Pool Investors and the Defrauded

Investors assumed different levels of risk and, in fact, the risks taken by the

Defrauded Investors were realized. See JA at A-1452 (noting that the real estate

was purchased at “the height of the commercial real estate boom, and the fair

market value of these properties had fallen substantially”); JA at A-1720 (noting

that the values of the real estate properties had “fallen substantially … primarily as

a result of the collapse of the United States real estate market.”). The Commodity

methods of speculating in commodities, based on a purported principal protection component, pursuant to which a portion of the proceeds of the offerings were to be invested in United States government securities and investment grade securities. JA at A-758–A-759.

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Pools, in contrast, were unaffected by the real estate crash and did not lose their

value. See JA at A-828 n.7, A-1071, A-1340.

As the court acknowledged in Enterprise Trust, given how greatly the

Commodity Pool investments differed from the real estate investments, it was

inequitable to approve a pro rata distribution among them in this case.

3. The Commodity Pool Investors and the Defrauded Investors Did Not Give Control Over Their Assets to the Same Entity

The Commodity Pool Investors did not relinquish full control of their assets

to a wrongdoer—that is what the Defrauded Investors did. JA at A-483, A-739–A-

758, A-1069–A-1071. Instead, the Commodity Pool Investors chose to invest in

heavily regulated investments that were not owned by the Wextrust Defendants

and through which the Commodity Pool Investors could retain ownership of their

investments. JA at A-1069–A-1071; see also 17 C.F.R. § 4.20(a)(1), (c). Since the

investors gave control over their investments to different entities, they were not

similarly situated. See Rolando, 2008 WL 5225851, at *3-4 (finding investors

similarly situated where they all ceded control of their assets to same defendant).

4. The Commodity Pool Investments Did Not Share a “Reasonably Close Resemblance of Facts and Circumstances” with Other Investments

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The facts and circumstances surrounding the Commodity Pool Investments

and the other Wextrust investments were completely different. See Lizardo, 270

F.3d at 101 (finding that entities are similarly situated only if there is a “reasonably

close resemblance of facts and circumstances”). Malek (along with the other

investors in the Commodity Pools) did not purchase shares or an ownership

interest in a real estate investment like the Defrauded Investors. Rather, the

Commodity Pool Investors pooled their money together in a unique investment

vehicle—a commodity pool, and granted WCM authority to manage the company

and make trading decisions. See, e.g., JA at A-1005– A-1006, A-1018–A-1019, A-

1030–A-1031, A-1044–A-1045, A-1069–A-1071.

A commodity pool is an “investment trust, syndicate, or similar form of

enterprise operated for the purpose of trading commodity futures or option

contracts,” which is “typically thought of as an enterprise engaged in the business

of investing the collective or ‘pooled’ funds of multiple participants in trading

commodity futures or options, where participants share in profits and losses on a

pro rata basis.” See CFTC Glossary, at http://www.cftc.gov/educationcenter

/glossary/glossary_co.html. These particular investments were vehicles for

speculating in exchange traded futures and options contracts, as well as spot

foreign currency markets, and for speculating in commodities, based on a

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purported principal protection component, pursuant to which a portion of the

proceeds of the offerings were to be invested in United States government

securities and investment grade securities. JA at A-758–A-759 (First Interim

Report).

The assets of the Commodity Pools were maintained at Fortis, a futures

commission merchant, and other entities, separate and apart from any Wextrust

Entity. JA at 1071; see also 7 U.S.C. §1a(20). The Commodity Pools were not

owned by Wextrust, and no Wextrust Defendant was affiliated with these

Commodity Pools. JA at A-998–A-999, A-1069–A-1071. No fraud occurred in

the Commodity Pools. JA at A-1340.

By contrast, the Defrauded Investors invested their assets in various

Wextrust Entities in which a massive fraud occurred. JA at A-743–A-758 (First

Interim Report). These investments were in limited liability companies that held

title to real estate or other specific property. JA at A-252–A-253, A-743–A-758.

All of these investments were offered by Wextrust. JA at A-742–A-758 (First

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Interim Report). None of these types of investments are governed by the

commodities laws.7

5. The Commodity Pool Investors Had a Different Relationship to the Defendants than the Defrauded Investors

The Commodity Pool Investors had a significantly different relationship to

the Wextrust Defendants than the Defrauded Investors. Again, the Defrauded

Investors invested directly with Wextrust entities that owned the real estate assets.

By contrast the Commodity Pool Investors invested in commodity pools that were

merely managed by WCM, a subsidiary of a Wextrust Defendant, and retained

ownership of the Commodity Pool assets. JA at A-999, A-1069–A-1071. The

Commodity Pool Investors and the Defrauded Investors were not similarly situated

in their relationship to Wextrust. Credit Bancorp I, 290 F.3d at 88-89 (requiring

that investors be similarly situated “with respect to their relationship to the

defrauders”).

7 The Receiver has argued that all investors’ circumstances were “similar” on account of a National Futures Association (“NFA”) complaint filed against WCM and Paul Adrian. In contrast to the SEC complaint filed against the Wextrust Defendants alleging a massive ponzi scheme defrauding investors out of millions of dollars under false pretenses, however, the NFA complaint alleges regulatory violations relating to “registration of associated persons” and failure to supervise. See JA at A-1497.

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6. The Commodity Pool Investors Did Not Understand Their Investments to Be “Part of a Whole” with the Defrauded Investors

The Commodity Pool Investors did not consider themselves “part of a

whole” with the other Wextrust investors and had no reason to believe they “shared

a common fortune or fate” with those investors. See Eustace, 2008 WL 471574, at

*8; Rolando, 2008 WL 5225851, at *4. The Commodity Pool investments and the

other Wextrust investments involved different investment products, which were

not made from the same pool of assets and which were not jointly marketed. JA at

A-996, A-1069–A-1071, A-1340. In fact, as the Commodity Pool investments had

to be kept separate from other investments—as a matter of law, the Commodity

Pool Investors had no reason to believe that their investments would share

anything at all with the other Wextrust investments. Since the Commodity Pool

Investments and the other Wextrust investments were not “part of a whole” and the

investors had no reason to believe they “shared a common fate,” they were not

similarly situated. Eustace, 2008 WL 471574, at *8 (finding investors similarly

situated where they were offered joint marketing materials for their investments

and where the investors believed that their assets would all be rolled into the same

pool of assets); Rolando, 2008 WL 5225851, at *4 (finding investors similarly

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situated where the defendant made clear that he would be making investment

decisions for the group as a whole).

B. The Commodity Pool Funds Were Not “Commingled”

To justify including the $17.6 million invested by the Commodity Pool

Investors—funds invested in entities over which the Receiver had no authority—

the Receiver also argued that the $17.6 million had been sufficiently

“commingled” with the fraudulent funds to justify their inclusion in the

receivership estate. The Commodity Pool assets, however, were minimally, if at

all, commingled, and their inclusion in the receivership estate was improper. The

District Court abused its discretion in finding that the Commodity Pool assets were

sufficiently commingled with the fraudulent assets to justify a pro rata

distribution.8

1. The Activity Between the Funds Was Not “Commingling”

The transactions the Receiver relied on to justify his pro rata distribution of

the receivership assets did not constitute commingling. Commingling exists where

funds are used on a pure “availability” and “cash flow needs basis” without regard

8 The District Court acknowledged that the level of commingling necessary to warrant a pro rata distribution of assets is unclear. Byers, 637 F. Supp. 2d at 178 (“the law does not appear to require more than that”) (emphasis added); SPA at SPA-26.

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to the source or intended use of the funds and without the knowledge or consent of

affected investors or creditors. SEC v. Sunwest Mgmt, Inc., No. 09-6056, 2009 WL

3245879, at *5-7 (D. Or. Oct. 2, 2009). That is not what happened here.

a. No Commingling Occurred in the Commodity Pools

The Commodity Pool assets were separate assets that were not commingled

with the assets of the Wextrust Defendants. The assets of the Commodity Pools

were used for their intended purpose—to serve as margin for commodities trading,

and were not part of the ponzi scheme that is at the core of the SEC’s action herein.

JA at A-106–A-142 (SEC Complaint); JA at A-1069–A-1071, A-1340. There is no

evidence that WCM, which managed the commodity pools, commingled funds.

Once the assets were placed in the commodity pools, the Wextrust Defendants no

longer had access to them, and no commingling could occur.

To support his allegations that commingling occurred, the Receiver ignores

the fact that the alleged commingling occurred before the funds were ever invested

in the Commodity Pools. JA at A-1976–A-1079, A-1081–A-1082. For instance,

the Receiver relies on a transaction involving Mr. Costa whereby he requested that

some of his Wextrust investments be sold and the proceeds transferred to a

Commodity Pool investment. JA at A-1076–A-1077. To redeem Mr. Costa, the

Wextrust principals fraudulently used funds from other Wextrust accounts. Id.

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Thus, it was Wextrust—in order to release the assets that Mr. Costas requested—

that commingled funds, not WCM or the Commodity Pools.

b. The Commodity Pool Funds Made Legitimate Loans to Wextrust Entities

The Receiver’s other allegations of commingling in the Commodity Pools

involve legitimate loans between the Commodity Pools and Wextrust Capital, one

of the Wextrust Defendants. See JA at A-1080; JA at A-928. The WDF Fund

made three loans to Wextrust Capital, all of which were paid in full by August 14,

2007. JA at A-928. Valid loans—particularly where the investors had knowledge

of the transaction—do not constitute commingling. Sunwest, 2009 WL 3245879,

at *6-8; see also SEC v. Murphy, 626 F.2d 633, 638 (9th Cir. 1980) (affirming

judgment in part because the issuer did not disclose that it was “commingling the

funds from the various partnerships”); SEC v. Pittsford Capital Income Partners,

L.L.C., No. 06 Civ 6353, 2007 WL 2455124, at *11-12 (W.D.N.Y. Aug. 23, 2007)

(defendants made material omissions by “never disclos[ing] that the separate bank

accounts . . . had been closed and all funds commingled into one single account” in

contravention of stated prohibition on commingling).

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2. These Transactions Are Not Sufficient to Find Commingling in Commodity Pool Funds

Even if this Court finds that the transactions described above involved

commingling between the Commodity Pool funds and the Wextrust Defendants,

these isolated transactions are not sufficient to justify a pro rata distribution

because only minimal commingling occurred. Cf. Sunwest, 2009 WL 3245879, at

*5-8; United States v. Ward, 197 F.3d 1076, 1083 (11th Cir. 1999); SEC v. Better

Life Club of America, Inc., 995 F. Supp. 167, 179-81 (D.D.C. 1998); Eustace, 2008

WL 471574 at *7.

a. Minimal, if Any, Commingling Occurred

Minimal, if any, commingling occurred between the assets in the

Commodity Pool funds and the assets under the control of the Wextrust

Defendants. At most, the Receiver demonstrated that a handful of instances in

which the Wextrust Defendants removed cash—to the Commodity Pool funds. JA

at A-1079–A-1080. Significantly, the lines between the Commodity Pool funds

and the Wextrust Defendants were clear—and respected—and there is no evidence

that the money flowed back and forth between the Commodity Pools and the

Wextrust Entities without regard to the source or the intended use of the funds.

See Eustace, 2008 WL 471574 at *7; Sunwest, 2009 WL 3245879, at *5-7. Such

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minimal commingling is not sufficient to justify a pro rata distribution of assets.

See Sunwest, 2009 WL 3245879, at *8 (noting the “extensive” commingling).

b. The District Court Mistakenly Relied on Cases Involving Far More Commingling than that Present in this Case

Indeed, all of the cases relied upon by the District Court make clear that far

more commingling than occurred here is necessary to include the Commodity

Pools in the receivership estate for pro rata distribution. For example, the facts

differ substantially between this case and SEC v. Lauer, No. 03-80612-Civ, 2009

WL 812719 (S.D. Fla. March 26, 2009), a case the District Court found

“particularly instructive.” See Byers, 637 F. Supp. 2d at 177-78; SPA at SPA-24–

SPA-25. In Lauer, the court held that “untainted funds” “no longer exist[ed]” and

because all of the assets were tainted by fraud, the Lauer court did not perform an

analysis of the level of commingling necessary. Lauer, 2009 WL 812719, at *4-5

(“This is not a case of mere commingling of tainted and untainted funds in an

account.”). There is no such finding here with respect to the Commodity Pools.

Similarly, Ward involved extensive commingling such that the “illicitly-acquired

funds and the legitimately-acquired funds …. [could] not be distinguished from

each other.” Ward, 197 F.3d at 1083 (quoting United States v. Moore, 27 F.3d

969, 976-77 (4th Cir. 1994)). Also distinguishable is United States v. Real

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Property Located at 13328 & 13324 State Hwy. 75 North, 89 F.3d 551 (9th Cir.

1996), another case relied on by the District Court, which involved an “admittedly”

commingled account. Id. at 553. Here, there is no such admission. Better Life

Club, also relied on by the District Court, involved legitimate and fraudulently

obtained funds which were “freely co-mingled,” where defendants “helped

themselves” to the accounts at issue. 995 F. Supp. at 179-81. The level of

commingling—if any—in this case is far less than that present in Better Life Club.

Finally, in Eustace, the court found that there had been a “blurring of the

distinction between the Receivership Funds.” 2008 WL 471574, at *7. No such

“blurring” occurred here.

C. A Pro Rata Distribution Is Inequitable

The assets in this case should be returned to the Commodity Pool Investors,

not distributed pro rata because the case law permits the return of identifiable

assets to particular victims. See, e.g., Black, 163 F.3d at 196-97 (affirming return

of assets as the court lacked power over the assets because there was no proof that

the funds were assets of defendant or that investors were wrongdoers); City of

Philadelphia v. Lieberman, 112 F.2d 424, 426 (3d Cir. 1940) (ordering return of

assets placed in trust account beyond control of the insolvent). As the Second

Circuit recognized in Credit Bancorp, “[i]n those case the reason the assets were

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returned was … because the assets had somehow been segregated in the manner of

true trust accounts and/or had never been placed in the defrauder’s control.” 290

F.3d at 89-90.

The Commodity Pool assets here were segregated from the other Wextrust

assets in commodity pools, which are akin to trusts. See 17 C.F.R. § 4.10(d)(1)

(defining commodity pool as an “investment trust”). “It is settled that a receiver of

an insolvent corporation is not entitled to possession of securities lawfully held in

trust.” Lieberman, 112 F.2d at 426; Black, 163 F.3d at 196. Therefore, since

commodity pools are akin to trusts, the Receiver was not entitled to possession of

the Commodity Pool assets.

In addition, the assets in the commodity pool were never placed in the

defrauder’s control. Rather, they were managed by Paul Adrian at WCM, who has

not been accused of any wrongdoing, and the investors retained ultimate control

over their investments. See JA at A-483, A-1069–A-1071.

Since the Commodity Pool assets were segregated from the Wextrust assets

in accounts akin to trusts and were never placed in the defrauder’s control, the

proper distribution in this case was one where the assets were returned to

Commodity Pool Investors. Credit Bancorp I, 290 F.3d at 89-90.

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CONCLUSION

For all the foregoing reasons, the Court should reverse the District Court’s

Order of July 23, 2009 approving the Distribution Plan, and remand this cause to

the District Court for release of the Commodity Pool assets to the Commodity Pool

Investors.

Dated: November 16, 2009 Respectfully submitted,

THOMAS ALEXANDER & FORRESTER LLP

By: Emily Alexander 14 27th Avenue Venice, California 90291 Telephone: (310) 961-2536 Facsimile: (310) 526-6852

Attorney for Appellant Martin Malek

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CERTIFICATE OF COMPLIANCE WITH RULE 32(a) This brief complies with the type-volume limitation of Fed. R. App. P.

32(a)(7)(B) because:

This brief contains 10,778 words, excluding the parts of the brief exempted

by Fed. R. App. P. 32(a)(7)(B)(iii).

I make this representation based upon the word count generated by the word

processing software used to prepare this brief. The font used for the brief is Times

New Roman in 14-point type.

Counsel for Appellant

Dated: November 16, 2009

SPECIAL APPENDIX

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STATE OF NEW YORK COUNTY OF NEW YORK

) ) )

ss.:

AFFIDAVIT OF SERVICE BY OVERNIGHT EXPRESS MAIL

I, , being duly sworn, depose and say that deponent is not a party to the action, is over 18 years of age and resides at the address shown above or at

On November 16, 2009 deponent served the within: Brief and Special Appendix for Claimant-Appellant Martin Malek

upon: JOHN WARREN DEWEY & LEBOEUF LLP 1101 New York Avenue, NW Washington, D.C. 20005-4213 jwarren@DeweyLeBoeuf.com Attorneys for Receiver-Appellee

Timothy J. Coleman

DAVID LISITZA U.S. SECURITIES AND EXCHANGE COMMISSION 100 F Street NE Washington, DC 20548 lisitzad@sec.gov

the address(es) designated by said attorney(s) for that purpose by depositing 2 true copy(ies) of same, enclosed in a postpaid properly addressed wrapper in a Post Office Official Overnight Express Mail Depository, under the exclusive custody and care of the United States Postal Service, within the State of New York and electronically by email. Sworn to before me on November 16, 2009

LUISA M. WALKER Notary Public State of New York

No. 01WA6050280 Qualified in New York County

Commission Expires Oct 30, 2010

Job # 226151