In re Manhattan Inv. Fund Ltd.

• Decision Date: 17 December 2007
• Docket Number: No. 07 Civ. 2511(NRB).,No. 00-10921(BRL).,No. 00-10922 (BRL).,Adversary No. 01-02606.,00-10922 (BRL).,00-10921(BRL).,07 Civ. 2511(NRB).
• Citation: 397 B.R. 1
• Parties: In re MANHATTAN INVESTMENT FUND LTD., et al., Debtors. Bear, Stearns Securities Corp., Appellant, v. Helen Gredd, Chapter 11 Trustee for Manhattan Investment Fund Ltd., Appellee.
• Court: U.S. District Court — Southern District of New York

Page 1

397 B.R. 1

In re MANHATTAN INVESTMENT FUND LTD., et al., Debtors Bear, Stearns Securities Corp., Appellant, v. Helen Gredd, Chapter 11 Trustee for Manhattan Investment Fund Ltd., Appellee.

No. 00-10922 (BRL).

No. 00-10921(BRL).

No. 07 Civ. 2511(NRB).

Adversary No. 01-02606.

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

December 17, 2007.

COPYRIGHT MATERIAL OMITTED

Daniel E. Reynolds, Lankier Siffert & Wohl LLP, New York, NY, for Chapter 11 Trustee.

Harry S. Davis, Schulte Roth & Zabel LLP, New York, NY, for Bear, Stearns.

MEMORANDUM and ORDER

NAOMI REICE BUCHWALD, District Judge.

Before this court is Bear, Stearns Securities Corp.'s ("Bear Stearns") appeal of the Bankruptcy Court's January 9, 2007 Memorandum Decision Denying Defendant's Motion for Summary Judgment to Dismiss and Granting Trustee's Motion for Summary Judgment. The cross motions for summary judgment were addressed to Count I of the complaint brought by the Trustee of the Manhattan Investment Fund (the "Fund"). Gredd v. Bear Stearns Securities Corp. (In re Manhattan Fund Ltd.), 359 B.R. 510 (Bankr.S.D.N.Y. 2007). Count I seeks to avoid $141.4 million of transfers made by the Fund into its margin account at Bear Stearns in the year prior to Fund's bankruptcy.¹ The Bankruptcy Court ruled that the transfers should be avoided because (1) the transfers were made with "actual intent to hinder, delay, or defraud the Fund's creditors" as defined by Section 548(a)(1)(A) of the Bankruptcy Code (the "Code"); (2) Bear Stearns was an "initial transferee" under Section 550(a) of the Code; and (3) Bear Stearns failed to prove that it accepted the transfers in good faith under Section 548(e) of the Code. Bear Stearns maintains that each of these findings were erroneous.

For the reasons set forth below, we affirm in part and reverse in part.

BACKGROUND

As this is the fifth opinion we have issued in this case, we only briefly review the facts.² The Fund was a hedge fund controlled by Michael Berger, whose strategy of short selling technology stocks in the late 1990s, was financially disastrous.³ Berger hid the losses—which eventually totaled $394 million—by fraudulently representing that the Fund was profitable. Concealing the Fund's status from its brokers, auditors, and other service providers, Berger persuaded new individuals to invest and paid off old investors with newly acquired funds.

The Prime Broker Relationship

Bear Stearns served as the Fund's prime broker. In that capacity, it facilitated the Fund's short selling activities by borrowing stocks from third parties, selling them for the Fund, and placing the proceeds in a "short account" which credited the proceeds to the Fund. See Appx. to Def. Br. at A656 (Expert Rep. of Michael T. Curley). To close out its short positions, the Fund would direct Bear Stearns to repurchase the stocks and return them to the lenders. However, because Bear Stearns had originally borrowed the stocks, it was the party that had the obligation to return the stocks while the Fund had open short positions. As a result, if the Fund failed to cover, Bear Stearns was itself exposed to a loss.

Margin Account

To support its trading activity, in addition to the short account, the Fund was required to keep a separate "margin account" at Bear Stearns, which is the account at issue in Count I and herein. Under Regulation T of the Board of Governors of the Federal Reserve Board ("Regulation T"), the Fund was required to deposit into this account 50% of the value of any short positions that were opened on a given day—this is referred to as the "initial federal margin requirement." See id. at A655. In addition, Bear Stearns had its own "house" margin requirement of 35%, referred to as a "maintenance margin requirement."⁴ This requirement meant that the Fund was obligated to maintain an amount equal to 35% of the value of its open short positions on deposit in its margin account at Bear Stearns at all times. During the year preceding the Fund's bankruptcy, the Fund transferred $141.4 million into this account to support its trading activity. Some of this amount was presumably transferred into the account to enable the Fund to establish new short positions and some of this amount was transferred to meet margin calls made by Bear Stearns to ensure compliance with its maintenance margin level.

The account agreement between Bear Stearns and the Fund contained provisions designed to protect Bear Stearns from the risk associated with the stock loans it made to the Fund. In addition to giving Bear Stearns a security interest in the money in the margin account, the agreement allowed Bear Stearns to:

1) Set any level of maintenance margin for the account;⁵

2) Prevent the Fund from withdrawing money from its account while there were open short positions supported by the account; and

3) Use the funds in the account to liquidate the Fund's open short positions, with or without the Fund's consent.

SEC Rule 15c3-3 also applied to the arrangement between Bear Stearns and the Fund. It precluded Bear Stearns from using any monies in the account for purposes unrelated to the Fund's trading. See 17 C.F.R. § 240.15c3-3-(e)(2). It is undisputed that at all times Bear Stearns acted in accordance with the account agreement and SEC Rule 15c3-3.

Bear Stearns's Inquiry Into Berger's Fraud

Turning to the facts related to the notice Bear Stearns received about Berger's fraud and to Bear Stearns's response, we note at the outset that there is no suggestion that Bear Stearns had actual knowledge of or was a participant in Berger's fraud. The first inkling that there might be an issue with the Fund came in December 1998 when Fredrick Schilling, a Senior Managing Director at Bear Stearns had a conversation at a cocktail party with an individual from European Investment Management (EIM) who stated that the Fund was reporting a 20% profit for the year. Appx. to Def. Br. A971 (Dep. of Fredrik Schilling). At that time, Schilling believed the Fund was losing money and thus asked the individual to have his boss at EIM call Schilling the next day. The next day, Schilling received a call from Arpad Busson of EIM, who asked if the Fund's reported performance corresponded to Bear' Stearns's records.⁶ Id. at A1295-96 (Dep. of Arpad Busson). That same day, Schilling also discussed the matter with others at Bear Steams and was told that the Fund was indeed losing money. In fact, the Fund had lost between $150 and $200 million in 1998 alone.⁷ See Appx. to Pl. Br. A773-74 (Dep. of John Callanan).

After the call with Busson and internal discussions, Bear Stearns arranged a call with the Fund's introducing broker—Financial Asset Management—and Berger himself. Berger said that the discrepancy between the losses sustained in the Bear Stearns account and the Fund's reported performance was due to the fact that the Fund used as many as eight other prime brokers to carry out its investment activities. Appx. to Def. Br. A994 (Dep. of Fredrik Schilling).

While Bear Stearns apparently viewed Berger's explanation as reasonable, it nevertheless did not cease its inquiry into the Fund's activities. Bear Stearns contacted the Fund's administrator to make sure that it was receiving the Fund's daily trading activity reports produced by Bear Stearns. Id. at A1032. Schilling also contacted the Fund's auditor, Deloitte & Touche, to inform it of the inquiry into the Fund's performance and of Berger's explanation. Schilling also asked "Deloitte to be keen and careful with respect to the Fund's upcoming audit." Def. Br. at 36 (citing Appx. to Def. Br. A976 (Dep. of Fredrick Schilling)).

Months later, Schilling met Busson at a conference and was told that because Berger refused to release the Fund's financial information—including the list of prime brokers being used by the Fund—to EIM without a confidentiality agreement, EIM was in the process of redeeming its clients' investments in the Fund. Appx. to Def. Br. A1051-52 (Dep. of Fredrick Schilling). According to Bear Stearns, it was informed by Deloitte in the spring of 1999 that the Fund's audit had occurred without issue and that the Fund was in good standing.

In the fall of 1999, Schilling continued to have discussions with industry contacts about the Fund and also spoke with another Deloitte auditor to urge caution. By November 1999, Bear Stearns was making margin calls to the Fund almost daily and was considering raising the Fund's maintenance margin requirement. See Appx. to PI. Br. A450-51, A592 (Dep. of Christopher Engdall). In December, a series of incidents led Bear Stearns to have renewed concerns about the accuracy of Berger's story.⁸ Thus, Bear Stearns ran a credit check—which did not show more than one prime broker—and called a number of other prime brokers and learned that they had no relationship with the Fund. Id. at 1085-86. After accepting a confidentiality agreement, Bear Stearns was able to obtain the Fund's financial statements, which revealed that the Fund had only one prime broker. See id. at 1091. Bear Stearns then reported the Fund to the SEC, marking the beginning of the end for the Fund.

DISCUSSION

Our jurisdiction to hear this appeal of the Bankruptcy Court's order derives from 28 U.S.C. § 158(a).⁹ We review the Bankruptcy Court's order of summary judgment de novo. Shimer v. Fugazy (In the Matter of Fugazy Express, Inc.), 124 B.R. 426, 430 (S.D.N.Y.1991); see also Adelphia Business Solutions, Inc. v. Abnos, 482 F.3d 602, 607 {2d Cir.2007). Summary judgment is appropriately granted to a party if "there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law."¹⁰ Fed.R.Civ.P. 56(c); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986); see also Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Thus, the Bankruptcy Court's ruling should be affirmed if, based on the...