Grede v. the Bank of N.Y. Mellon

• Decision Date: 03 November 2010
• Docket Number: No. 08 C 2582,08 C 2582
• Citation: 441 B.R. 864
• Parties: Frederick J. GREDE, not individually but as Liquidation Trustee for the Sentinel Liquidation Trust, Plaintiff, v. The BANK OF NEW YORK MELLON and the Bank of New York Mellon Corp., Defendants.
• Court: U.S. District Court — Northern District of Illinois

441 B.R. 864

Frederick J. GREDE, not individually but as Liquidation Trustee for the Sentinel Liquidation Trust, Plaintiff,
v.
The BANK OF NEW YORK MELLON and the Bank of New York Mellon Corp., Defendants.

No. 08 C 2582.

United States District Court,
N.D. Illinois,
Eastern Division.

Nov. 3, 2010.

441 B.R. 867

Catherine L. Steege, Chris C. Gair, Daniel Richard Murray, J. Kevin McCall, Jeffrey Scott Eberhard, John F. Kinney, Kevin Case, Michael Lance Cebula, Robert Jack Blazejowski, Vincent E. Lazar, Jenner & Block LLP, Chicago, IL, for Plaintiff.

Hector Gonzalez, Matthew D. Ingber, Paula Garrett Lin, Rebecca Sarah Kahan, Mayer Brown LLP, New York, NY, Sean T. Scott, Mayer Brown LLP, United States Trustee, Office of the United States Trustee, John H. Squires, United States Bankruptcy Court, Chicago, IL, for Defendants.

MEMORANDUM OPINION AND ORDER

JAMES B. ZAGEL, District Judge.

I. BACKGROUND

Plaintiff Liquidation Trustee alleges the following counts against Defendants: (1)

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avoidance and recovery of fraudulent transfers pursuant to §§ 548(a)(1)(A) and 550(a) of the Bankruptcy Code; (2) avoidance and recovery of fraudulent transfers pursuant to 740 Ill. Comp. Stat.. 160/5(a)(1) and 160/8(a), and §§ 544(b)(1) and 550(a) of the Bankruptcy Code; (3) avoidance and recovery of preferential transfers pursuant to §§ 547(b) and 550(a) of the Bankruptcy Code; and (4) equitable subordination of claims and transfer of subordinated lien pursuant to § 510(c) of the Bankruptcy Code. Defendants filed a counterclaim seeking declaratory judgment that Defendants have a valid, first-priority, perfected security interest in the lien that is the subject of the litigation. Defendants also allege breach of contract and request indemnification for attorneys' fees and expenses, and, if liable to Trustee, a setoff of any damages due to the Bank as a result of Sentinel's alleged breach of contract and indemnification of fees and expenses.

A bench trial was set in this matter for April 19, 2010. A few weeks prior to the trial date, Defendants moved for summary judgment. I granted Plaintiff's request to take the motion with the case. The following opinion and ruling addresses both the motion for summary judgment and the bench trial.

II. STATEMENT OF UNDISPUTED FACTS¹

Parties

1. The Sentinel Liquidation Trust (the "Trust") is a liquidating trust created under the Fourth Amended Chapter 11 Plan of Liquidation (the "Plan") for Sentinel Management Group, Inc. ("Sentinel"). The effective date of the Plan was December 17, 2008. Plaintiff Frederick J. Grede was formerly the chapter 11 trustee for Sentinel. On December 17, 2008, pursuant to the terms of the Plan, Grede was appointed Liquidation Trustee of the Trust (the "Trustee").

2. Defendant The Bank of New York (n/k/a The Bank of New York Mellon) is a state-chartered bank with its principal

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place of business located in New York, New York. It is a subsidiary of Defendant The Bank of New York Mellon Corp. (defendants are collectively referred to herein as, "BNYM" or the "Bank").

3. Defendant The Bank of New York Mellon Corp. is a corporation organized under the laws of Delaware, with its principal place of business located in New York, New York. It is the successor-in-interest to The Bank of New York, Inc. and was formed in July 2007 through a merger between The Bank of New York, Inc. and Mellon Financial Corporation.

Sentinel's Business

4. Sentinel was registered with the Securities and Exchange Commission ("SEC") as an Investment Adviser. (TTX 93A; Tr. 196:5-12.)

5. Sentinel was registered with the Commodity Futures Trading Commission ("CFTC") as a futures commission merchant ("FCM"). (TTX 93A; BTX 1.)

6. On May 7, 1981, Sentinel received a "no-action" letter from the Division of Trading and Markets ("Division") of the CFTC that exempted Sentinel from the net-capital requirements applicable to registered FCMs. (TTX 1; Bjarnason Dep. Tr. 29:21-32:16.)

7. The Division's no-action letter required that Sentinel meet certain conditions in order to remain exempt from the CFTC's net-capital requirements. (TTX 1.)

8. Sentinel never solicited or accepted "orders for the purchase or sale of any commodity for future delivery, or involving contracts for the sale of any commodity for future delivery, on or subject to the rules of any contract market." (TTX 1; TTX 93A; Tr. 2313:16-18.)

9. Sentinel's Designated Self-Regulatory Organization was the National Futures Association ("NFA"). (Tr. 772:17-19.)

10. Sentinel invested FCM's customer money. (TTX 93A; TTX 925; Tr. 234:22-235:23.)

11. Sentinel represented to the public and regulators that its Seg I portfolio consisted of funds and property of customers of other FCMs. (TTX 11; TTX 93A; Tr. 234:22-235:23.)

12. Sentinel had several customer groups with different investment strategies within the Seg I portfolio. (Tr. 311:1-15.)

13. Sentinel also invested proprietary or "house" funds of FCMs and hedge funds. (TTX 93A; Tr. 239:16-22.)

14. Sentinel represented to the public and regulators that its Seg III portfolio consisted of funds and property of FCM proprietary or "house" funds, as well as funds and property of hedge funds, trusts, and individuals. (TTX 93A; Tr. 239:16-22.)

15. Sentinel had several customer groups with different investment strategies within the Seg III portfolio. (TTX 925; Tr. 311:1-15.)

16. Sentinel had two principal investment portfolios: a "125 Portfolio" and a "Prime Portfolio." (TTX 925; BTX 314.) Sentinel represented that the 1.25 Portfolio's and Prime Portfolio's stated investment objectives were preservation of capital and liquidity and to achieve competitive yields. (TTX 925.)

17. Sentinel represented to its customers that the minimum credit rating for securities purchased for the 125 Portfolio would be A1/P1 for short term investments and AA for longterm investments. (TTX 925; BTX 109; BTX 314; Tr. 236:7-16.)

18. Sentinel represented to its customers that the minimum credit rating for securities purchased for the Prime Portfolio would be investment grade, typically defined as BBB or better. (TTX 925; BTX

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109; BTX 314; Tr. 238:23-239:11; Tr. 2820:4-8.)

19. By the end of 2005, Sentinel had begun to represent that it purchased securities for its own house account. (TTX 930; TTX 983.)

Oversight of Sentinel

A. CFTC

20. Sentinel filed a Form 1-FR on a monthly basis with the CFTC. (Tr. 255:8-14.)

21. Sentinel filed its audited financial statements on an annual basis with the CFTC. (TTX 85; TTX 118; TTX 120; TTX 165; TTX 225; Tr. 256:21-257:5.)

22. On October 7, 2003, the Division provided Sentinel with a list of questions about its business that it wanted Sentinel to answer. (BTX 71.)

23. On October 24, 2003, Sentinel responded to the Division's questions. (BTX 74.)

24. On November 21, 2003, Sentinel responded to additional follow-up questions that had been posed by the Division. (BTX 75.)

25. On January 21, 2004, the Division issued a letter confirming its view that funds deposited at Sentinel in Seg I would continue to count towards Sentinel's customers' segregation requirements under the Commodity Exchange Act and CFTC Rules and that Sentinel's client FCMs' house funds held in Seg III would qualify, for the purpose of computing their minimum adjusted net capital pursuant to CFTC requirements, as current assets. (TTX 93A; TTX 188; Tr. 217:7-227:9.)

26. The Division received a copy of the 1997 Securities Clearing Agreement between BNYM and Sentinel. (BTX 11.)

27. The Division received a copy of TTX 11. (TTX 93A; BTX 74.)

B. NFA

28. The NFA conducted examinations of Sentinel including in 2003, 2004, and 2006. (BTX 60; BTX 63; BTX 105; BTX 106; BTX 107; BTX 108; BTX 111; BTX 179; BTX 193; BTX 226; BTX 531.) The last NFA examination of Sentinel was in 2006. (BTX 179; BTX 193; BTX 226.)

29. In connection with the NFA's examination of Sentinel's books and records as of July 31, 2003, BNYM responded to the NFA's account balance confirmation requests. (BTX 60.)

30. In connection with the NFA's examination of Sentinel's books and records as of September 30, 2004, BNYM responded to the NFA's account balance confirmation requests. (BTX 105; BTX 106; BTX 107.)

31. In connection with the NFA's examination of Sentinel's books and records as of March 31, 2006, BNYM responded to the NFA's requests for confirmation of certain account balances. (BTX 193.)

32. In August 2003, NFA employees drafted a memorandum intended to provide an overview of Sentinel and its operations. (BTX 531.)

33. The NFA received a copy of the 1997 Securities Clearing Agreement between BNYM and Sentinel. (BTX 111.)

C. McGladrey

34. Sentinel's independent outsider auditor, McGladrey & Pullen LLP and its predecessor Altschuler, Melvoin and Glasser LLP (collectively, "McGladrey"), issued an annual unqualified audit opinion attesting that Sentinel's statement of financial condition presents fairly, in all material respects, the financial position of Sentinel as of the respective year-end date for 2003-2006. (TTX 85; TTX 118; TTX 120; TTX 165; TTX 225.)

441 B.R. 871

35. In connection with McGladrey's audit of Sentinel's financial statements as of December 31, 2005, BNYM responded to McGladrey's account balance confirmation requests. (BTX 162; BTX 163.)

36. In connection with McGladrey's audit of Sentinel's financial statements as of December 31, 2006, BNYM responded to McGladrey's account balance confirmation requests. (BTX 213; BTX 214; BTX 215; BTX 219.)

D. SEC

37. Sentinel filed a Form ADV with the SEC on an annual basis. (BTX 121; BTX 249; BTX 757.)

38. Sentinel's independent auditor, McGladrey, filed with the SEC, on an annual basis, an Independent Accountant's Report stating that it had examined on a test basis Sentinel's books and records and that in its opinion Sentinel had complied with certain provisions of rules 204-2(b) and 206(4)-2 of the Investment Advisers Act of 1940, as of and during the respective period. (BTX 204.)

Sentinel's...