In re Lehman Bros. Inc.

• Decision Date: 08 December 2011
• Docket Number: No. 08–01420 (JMP) (SIPA).,08–01420 (JMP) (SIPA).
• Citation: 55 Bankr.Ct.Dec. 224,462 B.R. 53
• Parties: In re LEHMAN BROTHERS INC., Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

462 B.R. 53

55 Bankr.Ct.Dec. 224

In re LEHMAN BROTHERS INC., Debtor.

No. 08–01420 (JMP) (SIPA).

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

Dec. 8, 2011.

Hughes Hubbard & Reed LLP, James B. Kobak, Jr., Esq., David W. Wiltenburg, Esq., Robert B. Funkhouser, Esq., Anson B. Frelinghuysen, Esq., Eleni D. Theodosiou–Pisanelli, Esq., New York, NY, for James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc.

Cadwalader, Wickersham & Taft LLP, Howard R. Hawkins, Jr., Esq., Ellen M. Halstead, Esq., New York, NY, Mark C. Ellenberg, Esq., John H. Thompson, Esq., Washington, DC, for Morgan Stanley Investment Management Inc.

Clifford Chance U.S. LLP, Jennifer C. DeMarco, Esq., Anthony M. Candido, Esq., Sarah N. Campbell, Esq., New York, NY, for Pacific Investment Management Company LLC.Goulston & Storrs, P.C., Douglas B. Rosner, Esq., Gregory O. Kaden, Esq., Timothy J. Carter, Esq., Boston, MA, for Rogge Global Partners PLC on behalf of its customer GPIF.Securities Investor Protection Corporation, Josephine Wang, General Counsel, Kenneth J. Caputo, Senior Associate General Counsel, Washington, DC, for Securities Investor Protection Corporation.

MEMORANDUM DECISION CONFIRMING THE TRUSTEE'S DETERMINATION OF CLAIMS RELATING TO TBA CONTRACTS

JAMES M. PECK, Bankruptcy Judge.

Introduction

James W. Giddens (the “Trustee”), as trustee for the liquidation of Lehman Brothers Inc. (“LBI”) under the Securities Investor Protection Act of 1970, as amended (“SIPA”), has brought a motion (the “Motion,” ECF No. 4360) to confirm his determination that certain claims relating to TBA contracts do not qualify as customer claims against LBI's estate. The Motion raises a number of arguments, but, at its most elemental, points out that participants in the market for agency mortgage-backed securities (“Agency MBS”) who invested in these TBA contracts on a delivery-versus-payment basis or receipt-versus-payment basis did not transfer any securities or cash to LBI to hold on their behalf. Accordingly, such parties never formed the sort of custodial relationship with LBI that is essential to customer status under SIPA.

According to the Trustee, LBI's internal account statements and business records are fully consistent with his determination regarding customer status and reveal that at the time of commencement of LBI's SIPA case (the “Filing Date”) the TBA claimants had zero balances for both cash and securities. Principally as a result of the inability of these claimants to show any entrustment of property to LBI, the Trustee has concluded that the TBA claims do not fit the definition of customer claims under SIPA and should be classified as ordinary breach of contract claims and treated as unsecured claims. The Securities Investor Protection Corporation (“SIPC”) agrees wholeheartedly with the position of the Trustee and has submitted independent arguments that strongly support the Motion.¹

Three asset managers who are typical of the class of TBA claimants (the “Representative Claimants”) oppose the Motion and submit that the Trustee's determination fails to take into account both the expectations of LBI's customers who invested in TBA contracts and the commercial realities of a sophisticated and robust TBA marketplace that regards TBA contracts as the functional equivalent of the Agency MBS to which these contracts relate. They argue that, with assigned CUSIP numbers, these contracts resemble securities in so many material respects that they satisfy the definition of securities: notably, they trade like securities and have characteristics that are hard to distinguish from other instruments that are defined as securities for purposes of SIPA customer protection.

Also, because these contracts are the primary means by which investors gain access to the vitally important Agency MBS market and are an essential portal to investment in that market, the Representative Claimants believe that market participants should enjoy the same protections that would be available to holders of the not-yet-fully ripe “to be announced” Agency MBS securities themselves. They argue that these TBA contracts “walk and talk” just like securities, and so they must really be securities.

The Representative Claimants are Morgan Stanley Investment Management Inc. (“MSIM”), Rogge Global Partners PLC on behalf of its customer GPIF and Pacific Investment Management Company LLC. They assert that their clients are entitled to customer claim status under SIPA because, like others who have been granted allowed customer claims against LBI, their claims seek recoveries from the estate for net equity attributable to the trading of TBAs in their LBI accounts.

Following extensive briefing of the issues that included supporting declarations with respect to a factual record that for the most part is not in dispute, a hearing on the Motion took place on November 17, 2011 (the “Hearing”). Thereafter, in response to a request by the Court for clarifying citations to the evidentiary record, the parties submitted post-hearing memoranda to highlight those portions of the record that support their respective positions. The issues presented call for the Court to decide whether the Trustee correctly determined that claims based on TBA contracts are not properly classified as customer claims for purposes of SIPA.

The procedure here is similar to a motion for summary judgment, although strictly speaking this dispute does not arise in that context. Instead, as a means to efficiently create a factual record and eliminate the need for live testimony, the parties have agreed that the Court may consider as evidence all documents, including the opinions of experts and deposition transcripts, attached to the supporting declarations.

An uncommon procedural aspect of the Motion involves the role of the Representative Claimants themselves. They are not formally-anointed class representatives with the authority to act on behalf of all parties with TBA claims against LBI. Rather, this contested matter is a test case based on particular facts believed to be typical of TBA claims in general. The Representative Claimants are, as their name suggests, representative of the holders of such claims, and so this decision may have preclusive effect on other similarly situated claimants under a law of the case standard. However, deciding the Motion will not conclusively bind other parties with TBA claims who may be able to identify distinguishing facts or circumstances applicable to their own claims. Additionally, this decision will not directly impact the treatment of claims of the Representative Claimants (such as the pool claim of MSIM) or other holders of TBA claims that are not based on TBA contracts. ²

Accordingly, the procedural context for this dispute is not standard: the fact pattern arises out of an idiosyncratic aspect of the Agency MBS market and presents a matter of first impression that needs to be decided to promote the orderly administration of the LBI liquidation. As described more fully in the following sections of this decision, having considered the submissions of the parties and the arguments presented at the Hearing, the Court finds that the Trustee is correct in his determination that claims of the Representative Claimants relating to TBA contracts do not fit the definition of customer claims under SIPA and properly are classified as general unsecured claims against the estate. The Representative Claimants have placed undue reliance on In re Adler, Coleman Clearing Corp., 211 B.R. 486 (Bankr.S.D.N.Y.1997) ( “ Adler Coleman ”). That case does not support the proposition that they have a “net equity” claim under SIPA.

This conclusion flows naturally from the undisputed fact that the Representative Claimants never entrusted any property with LBI as their broker-dealer.³ Their account statements confirm transactions involving TBA contracts but not the holding of any customer securities or cash. The accounts were used to facilitate trading activity that, while closely related to the market for Agency MBS securities, did not involve the retention by the broker-dealer of customer property that is a necessary part of the definition of a customer claim. Simplistically and narrowly, without identified property in the hands of LBI, there can be no claim against the estate for the recovery of such property. The claims necessarily are for contract damages and not for “securities received, acquired or held” by LBI or cash on deposit with LBI “for the purpose of purchasing securities” under SIPA § 78 lll (2).

This is true despite the fact that the contractual rights associated with “to be announced” securities have notional value and may be traded, hedged and marked to market just like securities. The Representative Claimants have shown convincingly that TBA contracts are essential to the orderly functioning of the Agency MBS market, that these contracts have a number of features that make them look very much like securities and that they have become the predominant means by which investors gain access to the second-largest securities market in the United States. However, they have not shown that the trading activity in question—the purchase, sale or “pairing off” of a TBA contract—ever involved the delivery or entrustment of any property to LBI. This is the key factor that compels granting the Motion.

Although not essential to confirming the Trustee's determination, the Court has also considered whether TBA contracts are securities for purposes of SIPA. As discussed in the following section of this decision, TBA contracts have certain characteristics that give them both the appearance and functionality of securities. The fact that TBAs are listed on LBI's account statements in a manner comparable to the listing of securities transactions is one such characteristic. Another is that these contracts also trade in the market very much like securities, the CUSIP number being...