In re Adler, Coleman Clearing Corp.

• Decision Date: 13 March 1998
• Docket Number: Adversary No. 97/8423A.,Bankruptcy No. 95-08203 (JLG)
• Citation: 218 BR 13
• Parties: In re ADLER, COLEMAN CLEARING CORP., Debtor. Edwin B. MISHKIN, as SIPC Trustee for the Liquidation of the Business of Adler, Coleman Clearing Corp., Plaintiff, v. Daniel David ENSMINGER, et al., Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

218 B.R. 13 (1998)

In re ADLER, COLEMAN CLEARING CORP., Debtor.

Edwin B. MISHKIN, as SIPC Trustee for the Liquidation of the Business of Adler, Coleman Clearing Corp., Plaintiff, v. Daniel David ENSMINGER, et al., Defendants.

Bankruptcy No. 95-08203 (JLG), Adversary No. 97/8423A.

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

March 13, 1998.

Cleary, Gottlieb, Steen & Hamilton, New York City, for Trustee.

Zeisler & Zeisler, P.C., Bridgeport, CT, for Claimants.

Kohrman Jackson & Krantz P.L.L., Cleveland, OH, for Claimant Norman Bennett.

Anthony Motta, New York City, for Claimant Dr. David Sulman.

S.W. Azriliant, P.C., New York City, for Claimants Georgios and Maria Kapsalis.

DECISION ON TRUSTEE'S CROSS-MOTION FOR SUMMARY JUDGMENT UPHOLDING DETERMINATIONS CONCERNING CLAIMS OF CUSTOMERS WHO DID NOT RECEIVE TRADE CONFIRMATIONS

JAMES L. GARRITY, Jr., Bankruptcy Judge.

Adler, Coleman Clearing Corp. ("Adler" or "debtor"), formerly a registered broker-dealer and clearing firm, is subject to this liquidation proceeding under the Securities Investor Protection Act ("SIPA"). Hanover Sterling & Company ("Hanover") was formerly an introducing broker that cleared its trades through Adler prior to the commencement of this SIPA proceeding. Several former Hanover customers have filed SIPA customer claims against Adler to recover the securities and/or cash in their accounts at Adler. In or about December of 1996, Edwin B. Mishkin, Esq., as Securities Investor Protection Corporation ("SIPC") trustee for Adler's liquidation (the "trustee"), filed an Application for an Order Upholding the Trustee's Determination Denying Claims of Certain Customers Who Seek to Benefit from Fraudulent Transactions and Expunging Objections with Respect to those Transactions (the "Complaint").¹ Recently we denied a motion filed on behalf of 90 former Hanover customers whose claims are the subject of the Complaint for an order pursuant to Bankruptcy Rule 7012 and Fed. R.Civ.P. 12(b)(6) dismissing the Complaint for failing to state a claim upon which relief can be granted. See Memorandum Decision on Motion to Dismiss Complaint Seeking Judgment Upholding Trustee's Determination Concerning Certain Customer Claims, dated March 6, 1998 (the "Dismissal Decision"). In opposing that motion the trustee also cross-moved pursuant to Bankruptcy Rule 7056 and Fed.R.Civ.P. 56 for summary judgment upholding his determinations as to 65 of those former Hanover customers (the "Claimants").² We did not address the merits of cross-motion in the Dismissal Decision, but do so now. Claimants oppose the crossmotion. We grant it.

Facts

We presume familiarity with the Dismissal Decision, which, among other things, discusses relevant background information and the trustee's allegations in the Complaint. As necessary, we reiterate some of that information herein.

On February 27, 1995 (the "Filing Date"), SIPC commenced a liquidation proceeding against debtor under 15 U.S.C. § 78eee(b) in the United States District Court for the Southern District of New York. District Judge Loretta A. Preska thereafter removed the liquidation proceeding to this court and appointed the trustee to liquidate debtor's assets.

Prior to the Filing Date, Adler was a registered broker/dealer of securities and a clearing firm for 42 introducing broker/dealers. It was also a member of SIPC, the National Securities Clearing Corporation, and the National Association of Securities Dealers, Inc. It held approximately 66,000 active customer accounts on the Filing Date.

Hanover was one of the introducing firms that cleared trades through debtor. It was a registered broker/dealer that acted as an underwriter and market maker for various securities, including, among others, All-Pro Products, Inc. units, American Toys, Inc. common stock, Envirometrics, Inc. common stock and warrants, Mister Jay Fashions Int'l, Inc. common stock and warrants, Panax Pharmaceutical Co. Ltd. units, Play Co. Toys common stock, warrants and units, Porter McLeod common stock and warrants and Eagle Vision, Inc. common stock (collectively, the "House Stocks"). Hanover was the initial underwriter for all of the House Stocks except the Eagle Vision, Inc. common stock, and all of the House Stocks traded on the NASDAQ market, except Eagle Vision, which was listed on the "pink sheets". A Fully Disclosed Clearing Agreement (the "Clearing Agreement") governed Adler's relationship with Hanover. See June 12, 1997 Declaration of James Corsiglia in Opposition to the Motion to Dismiss the Trustee's Application and in Support of the Trustee's Cross Motion for Summary Judgment (the "Corsiglia Decl.") Ex. A.

The trustee contends that in early 1995, Hanover was confronted with a growing crisis. As the primary market maker and an underwriter for the original public offering of the House Stocks, it owned many of the House Stocks itself and used them to meet its capital requirements. Also, many of its customers owned large quantities of House Stocks. According to the trustee, a group of brokerage houses and persons related to those firms engaged in illegal "short-selling" of the House Stocks beginning sometime prior to February of 1995. The trustee alleges that Hanover originally attempted to respond to this massive short-selling pressure by acceding to the short sellers' extortion demands, but that the short-selling continued despite substantial payments made to them by Hanover. The concerted short-selling of the House Stocks caused downward pressure on their prices, and, according to the trustee, Hanover was aware that the selling could eventually force it into bankruptcy and result in enormous losses for its customers. The trustee contends that to support the price of the House Stocks, Hanover escalated its efforts to sell them to its retail customers, and began to record "phony purchases" by retail customers from its proprietary trading accounts. While Hanover's customers allegedly did not authorize these "buys", Hanover allegedly created debits in their accounts that they could never repay. Those debits purportedly were secured only by the artificially inflated value of the House Stocks.

The trustee alleges that beginning on or about Monday, February 13, 1995 — two weeks before Adler closed its doors— Hanover began to dump stock in its customers' accounts without informing them. Hanover's trading desk processed "buy" tickets for those transactions and Adler cleared the "buys". The Hanover customers who "bought" the House Stocks did not have the cash in their accounts to pay for them, and Adler automatically debited those customers' accounts in an amount equal to the price of the House Stocks. Adler also automatically credited Hanover's proprietary accounts with the proceeds, and Hanover was able to use that credit to "purchase" more House Stocks. The trustee contends that through this allegedly illusory buying and selling, Hanover temporarily supported the markets for the House Stocks, and thereby maintained its minimum net capital requirements.

The trustee asserts that by Friday, February 17, 1995, key Hanover officials understood that Hanover could not absorb the massive short-selling. They allegedly realized that Hanover's days were numbered, but continued to create fake "buys" of the House Stocks to prevent immediate depletion of Hanover's capital reserves, while simultaneously "selling" the House Stock out of the accounts of certain favored customers, and utilizing the proceeds of the "sales" to "buy" well-known securities with real value, including Apple, Dell, Ford, Cisco Systems, IBM, AT & T, Birmingham Steel and Microsoft (designated by the trustee and referred to herein as "Blue Chips"). In as much as there never was actually any cash to acquire the Blue Chips, but merely the proceeds of House Stocks whose prices were artificially and fraudulently inflated by Hanover's machinations, the trustee maintains that the Blue Chip "buys" that were used to benefit Hanover's favored customers were fake, and that the "sale" of the House Stocks was part of a scheme to defraud Adler and SIPC.

The trustee contends that between February 17 and 24, 1995, Hanover customers were forced to "buy" without their knowledge and against their wishes at least $45.1 million of House Stock at prevailing prices. For many Hanover customers, these alleged purchases were the only transactions ever recorded in their accounts. According to the trustee, at the same time, Hanover "sold" $31.5 million in House Stocks from the accounts of Hanover's favored customers, thereby replacing their holdings in House Stocks with cash. However, because SIPA only provides cash coverage up to $100,000, Hanover used the "cash" credits in those accounts to purchase $18.7 million in Blue Chips. The trustee alleges that most, if not all of Hanover's customers did not authorize the Blue Chip purchases, and that Hanover effected those transactions to give the favored customers the greatest and highest priority claim possible under SIPA.

Each Claimant was one of Hanover's favored customers. Some, but apparently not all, of them executed standardized customer agreements (the "Account Agreements") with Adler when they opened accounts at Hanover. See Statement of Edwin B. Mishkin, Trustee for the Liquidation of Adler, Coleman Clearing Corp., pursuant to Local Rule 7056-1 ("Trustee 7056-1") ¶ 5; Customers' Statement of Material Facts as to which There Are Genuine Issues to Be Tried pursuant to Local Rule 7056-1 ("Claimant 7056-1") ¶ 1; Corsiglia Decl.Ex. J. Those agreements provide in relevant part that "the confirmation of the receipt or execution of an order shall be conclusive or binding upon the undersigned if the undersigned does not object thereto in writing within five business days after Adler Coleman has sent the confirmation to the undersigned by mail or otherwise." Account Agreements ¶ 8(a). On February 24, 1995, the final day of Hanover's operation, Hanover "sold" the...