Earlier this year, the federal 7th Circuit Court of Appeals issued a major ruling against lenders. Although the case involved federal bankruptcy law, there is plenty for victims of bad banking behavior to celebrate. To put the case in context, some history is necessary.
Sentinel Management Group and BONY Mellon
For years, Sentinel was a sleepy investment management company. It helped commodity brokers segregate client accounts. It was a favorite of hedge funds too. The company’s primary business was simply providing account services. The hedge funds and commodity brokers did the investing while Sentinel did some of the back office work.
That relationship worked very well until Sentinel decided to start its own leverage trading business. And its timing couldn’t be worse, it really started ramping up and aggressive trading program in 2005 just before the market collapsed.
If Sentinel was segregating customer accounts like it was required to and simply used its own money for trading there wouldn’t be a problem. We know from companies like MF Global that not all money managers were following the law, however.
Enter Bank of New York Mellon (BONY). At first, BONY was a custodian for Sentinel’s client assets. As Sentinel decided to get into trading, BONY also became the company’s lender and clearing broker. That decision would create a conflict of interest and later be the bank's undoing.
In just three years, Sentinel’s borrowing from BONY skyrocketed from $30 million to $500 million. BONY wanted collateral for the loans. Where did the collateral come from? The supposedly segregated accounts belonging to Sentinel’s customers.
In late 2007, the scheme collapsed along with the economy. Sentinel’s customers were out over $900 million.
What were the customers to do? Sue Sentinel? They had no money. Claim the money in their accounts? Those accounts had been pledged to the bank.
The bankruptcy trustee decided to get back the $300 million in the customer accounts. The bank claimed those funds, however. What money was remaining had been pledged to BONY. The trustee asked the court to set aside the bank's lien interest and claimed the bank acted in bad faith by accepting customer funds as collateral.
If the bank was solely acting as a lender, it may have had an easier time escaping liability. Because it was Sentinel’s depository bank, however, the bank had a problem. During the trial, evidence revealed that the bank signed acknowledged that the funds held in Sentinel's customer accounts would be “segregated and treated as belonging to [Sentinel's] customers” and would “not be subject to [BONY's] lien or offset for, and on account of, any indebtedness now or hereafter owing [by Sentinel] to [BONY].” Sentinel needed that acknowledgment to demonstrate to regulators that its customer accounts were properly segregated.
If that isn’t enough, evidence revealed an internal email that said, “How can [Sentinel] have so much collateral? With less than [$20 million] in capital I have to assume most of this collateral is for somebody else’s benefit.” That email was sent from a senior BONY officer.
In a highly unusual ruling, a three judge appeals panel ruled in favor of the bank! Although the judges said the bank officials were “artless liars,” the court was convinced that the bankers were lying to simply cover up their inconvenience. While an appeal of that decision was pending, the same three judges pulled back their appeal and reversed their prior opinion. That was in 2013 but the case would drag on for another 3 years. [The trial court also found the bankers were lying, “There were instances during trial in which bank employees gave testimony I did not believe. Yet, in this case, lies on the witness stand coming from the mouths of some BNYM witnesses do not lead me to infer that the truth would help Trustee.”]
Finally, this year after the case was considered three separate times by the appeals court, the judges ruled that BONY’s own bad faith was enough to void its liens.
The decision is significant both for the victims of Sentinel’s theft scheme and for bank clients everywhere.
Absent the bank’s bad faith, BONY would have a priority lien on the collateral. The bank would have been allowed to take the money, not Sentinel’s customers.
The case is also important for other victims of bank fraud. Often when a Ponzi scheme or other fraud is exposed there is a search for culpable third parties. Because the fraudster is often headed for prison or has spent all the proceeds of the crime, fraud recovery lawyers need to find other deep pockets.
This case is even worse. In our opinion, not only did BONY have some knowledge of the wrongdoing, they also tried to keep the hundreds of millions of dollars of customer funds they were holding.
Did BONY know that Sentinel was stealing? We think so and ultimately a court of appeals thought they were acting in bad faith.
MahanyLaw and Judge, Lang & Kater – Lender Liability Lawyers "We Sue Banks"
The fraud recovery team at MahanyLaw and Judge, Lang & Katers helps customers and third parties who have lost money because of bank misconduct. We represent businesses or high net worth individuals with significant losses. (We never represent banks.)
Because we are based in the Midwest, our rates are reasonable. Because we sue banks for a living, we can usually get up to speed quite quickly and don’t “learn the law on your nickel.”
For more information, contact attorney Brian Mahany at [hidden email] or by telephone at 877-858-8018.