In re Adler, Coleman Clearing Corp.

• Decision Date: 11 June 2001
• Docket Number: 00 CIV 4217 (VM).,No. 00 CIV 4216 (VM),00 CIV 4216 (VM)
• Parties: In re ADLER, COLEMAN CLEARING CORP., Debtor. David A. Jackson, Donald D. Doty, John L. Nappi, Thomas Crouch, David Laskey, A.J. Marks, Jr., Charlotte Marks, Alfred Marks, Alfred J. Marks, Jr., Appellants, v. Edwin B. Mishkin, as Trustee of Adler, Coleman Clearing Corp., Appellee.
• Court: U.S. District Court — Southern District of New York

263 B.R. 406 (2001)

In re ADLER, COLEMAN CLEARING CORP., Debtor David A. Jackson, Donald D. Doty, John L. Nappi, Thomas Crouch, David Laskey, A.J. Marks, Jr., Charlotte Marks, Alfred Marks, Alfred J. Marks, Jr., Appellants, v. Edwin B. Mishkin, as Trustee of Adler, Coleman Clearing Corp., Appellee.

Nos. 00 CIV 4216 (VM), 00 CIV 4217 (VM).

United States District Court, S.D. New York.

June 11, 2001.

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Jed Horwitt, Stephen M. Kindseth, Zeisler & Zeisler, Bridgeport, CT, for appellants.

Mitchell A. Lowenthal, Cleary, Gottlieb, Steen & Hamilton, New York City, for appellee.

Kenneth J. Caputo, Wash. D.C., for Securities Investor Protection Corporation.

DECISION AND AMENDED ORDER

MARRERO, District Judge.

                                         TABLE OF CONTENTS
                                                                   Page
                                  INTRODUCTION                     416
                                   I. FACTS                   417
                A. THE PARTIES.....................................417
                B. THE ILLEGAL SHORT SELLING.......................418
                C. THE NET CAPITAL COMPLIANCE RULE AND HANOVER'S
                    RESPONSE TO ILLEGAL SHORT SELLING..............419
                

                D. HANOVER'S FINAL WEEK.......................................................421
                E. THE CLOSING OF HANOVER AND ADLER...........................................422
                F. PRIOR PROCEEDINGS..........................................................423
                                 II. STANDARD OF REVIEW                                       423
                                     III. DISCUSSION                                          424
                A. THE PARTIAL SUMMARY JUDGMENT MOTION........................................424
                   1. Appellants' Claims and the Bankruptcy Court's Rulings...................424
                   2. Contract Formation......................................................428
                   3. The Blue Chip Buys......................................................430
                      a. Cash in the Accounts ................................................430
                      b. Trade Date ..........................................................432
                      c. Effects of Hanover's Fraud ..........................................433
                B. CANCELLATION OF TRADES PURSUANT TO PROVISIONS OF
                    CONTRACTS ................................................................435
                C. AVOIDING THE TRADES AS FRAUDULENT TRANSFERS PURSUANT
                    TO THE BANKRUPTCY CODE ...................................................438
                   1. Avoidance Pursuant to 11 U.S.C. § 548(a)(1)(A).....................439
                      a. Hanover's Intent to Hinder, Delay or Defraud ........................439
                      b. Domination or Control of the Debtor .................................441
                          (i) Transferee's Intent ............................................443
                          (ii) Position to Control ...........................................447
                         (iii) Disposition of Debtor's Property ..............................448
                      c. Appellants' Responsibility ..........................................451
                          (i) Appellants' Theory and the Bankruptcy Court's Ruling ...........451
                          (ii) Agency Principles .............................................453
                         (iii) Hanover's Integrated Scheme ...................................457
                          (iv) Appellants' Innocence .........................................462
                   2. Avoidance Pursuant to 11 U.S.C. § 548(a)(1)(B).....................464
                      a. Reasonably Equivalent Value .........................................465
                          (i) Date of Valuation ..............................................466
                          (ii) The Potential Buy-In Value ....................................467
                      b. Adler's Insolvency ..................................................469
                   3. Defense of Value Given Pursuant to § 548(c) .......................470
                   4. Defense of Settlement Payments or Margin Payments Pursuant to § 546(e).471
                      a. The Parties' Arguments ..............................................472
                      b. The Bankruptcy Court's Rulings ......................................474
                      c. Applicability of the Defense ........................................474
                          (i) Settlement Payments ............................................475
                          (ii) Margin Payments ...............................................483
                         (iii) The Holistic Statutory Framework ..............................484
                D. AVOIDING THE TRADES PURSUANT TO § 544(b) AND NEW YORK
                    DEBTOR AND CREDITOR LAW ..................................................485
                E. RESCISSION OF CONTRACTS UNDER NON-BANKRUPTCY LAWS..........................486
                   1. Common Law Fraud .......................................................486
                      a. Hanover's Misrepresentations ........................................486
                      b. The Bankruptcy Court's Rulings and Factual Basis ....................487
                      c. Appellants' Responsibility ..........................................489
                      d. Reasonable Reliance .................................................489
                      e. Adler's Claimed Guarantee............................................491
                F. RESCISSION OF TRADES AS ILLEGAL CONTRACTS .................................492
                   1. Illegality Under Securities Laws .......................................492
                   2. Exceptions for Innocent Parties ........................................494
                                  IV. CONCLUSION AND ORDER                                    496
                 

INTRODUCTION

Innocence has many faces, and perhaps embodies as many notions of the word's meaning as the number of self-proclaimed innocents from time immemorial who have invoked the blessings of its absolution. Central to the appeal before the Court is a consideration of innocence: the limits of the concept, how far it validly expands and whose conduct it embraces — beyond the hyperbole to which the term often gives rise. In their opening argument, Appellants declare: "For the first time in American Jurisprudence, a court has held innocent customers liable for the frauds perpetrated by a market-maker simply because it was also their executing broker." Appellants' Brief, dated July 14, 2000 ("Appellants' Brief"), at 5.

In the same vein, repeatedly throughout their lengthy briefs here, as well as before the bankruptcy court, Appellants pronounce their blamelessness. Vigorously and indignantly, they portray themselves as "innocent public investors" whose only role in the events here at issue was their mistaken choice of unethical or dishonest brokers with whom they dealt at arms length and in good faith and for whose frauds and other misdeeds Appellants contend they should not be held responsible. Appellants' Reply Brief, dated November 17, 2000 ("Appellants' Reply"), at 1-2. By their account, Appellants are faultless victims of the bankruptcy Trustee's zealous pursuit of the proceeds of certain allegedly tainted securities transactions that are the subject of this appeal. Appellants seek to retain the benefits of bargains they struck with their corrupt brokers in connection with those trades, for this purpose invoking the shelter and safeguards of the Securities Investors Protection Act of 1970 ("SIPA"), 15 U.S.C. §§ 78 aaa-lll. See Appellants' Reply at 1, 3.

In this context, Appellants' remonstrances put in play here the definition and proper bounds of the notion of innocence. In its ordinary sense, innocence denotes an absence of a particular state of mind — for example, a lack of culpable knowledge or intent — which in turn generally derives from an absence of causal involvement by a person in the harms or undue gains associated with a given wrongful act. This lack of knowing participation serves as the innocent's defensive shield, justifying his claim to be screened or absolved of responsibility for the consequences of the underlying deed.

As unfolds below, however, and as is frequently the case even in connection with the most passionate incantations of the term, there is often more to innocence than meets the eye. Profoundly held convictions of one's own clean hands at times play tricks of the mind, blurring objectivity, concealing from comprehension or view the person's actual role in unavowed causes and effects, and impeding discernment of shades of involvement and responsibility not immediately apparent to the naked or subjective eye. And, beyond a person's own actions, whether the given conduct is individually or externally controlled, circumstances may prevail under which the law, in disregard of the innocent's protestations, and indeed at times even conceding whatever validity due them, may still impose liability, not on account of anything the person may have done or omitted to do, but, for reasons of equity or policy, by imputing to the apparent bystander the misconduct of a sufficiently related wrongdoer. By these means, the law recognizes that even innocent association with scoundrels has its limitations, and its costs. Occasions arise when the villain chooses to exploit the relationship and betray the trust, and then the supposed "innocent" may be obligated to pay a price. The operation of these principles drives much of what is at issue on this appeal.

I. FACTS¹

A. THE PARTIES AND THEIR TRANSACTIONS

Hanover Sterling & Company ("Hanover") was an introducing broker-dealer, located principally in New York City. Its main business was underwriting certain initial public offerings ("IPO's") of securities. Hanover would act as the market-maker for these securities (the "House Stocks"). As such, it held itself out as ready to buy House Stocks (for which it set a "bid" price) and sell House Stocks (for which it set an "ask" price). In particular, whenever a Hanover customer bought or sold House Stocks, Hanover acted as a "middle man" in the purchase or sale of those securities. Hanover was registered with the Securities...