Lehman Brothers Inc.

FOR PUBLICATION
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
)
In re: 	)
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LEHMAN BROTHERS INC., 	)
)
Case No. 08-01420 (JMP) (SIPA)
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Debtor. 	)
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MEMORANDUM DECISION CONFIRMING THE TRUSTEE'S DETERMINATION OF
CLAIMS RELATING TO REPURCHASE AGREEMENTS
HUGHES HUBBARD & REED LLP
Attorneys for James W. Giddens, as
Trustee for the SIPA Liquidation of Lehman Brothers Inc.
One Battery Park Plaza
New York, New York 10004
Michael E. Salzman, Esq.
SNR DENTON US LLP
Attorneys for Hudson City Savings Bank
1221 Avenue of the Americas
New York, New York 10020
Hugh M. McDonald, Esq.
– and –
2000 McKinney Avenue
Dallas, Texas 75201
Kym Rogers, Esq.
OTTERBOURG, STEINDLER, HOUSTON & ROSEN, P.C.
Attorneys for the FDIC, as receiver of Westernbank Puerto Rico
230 Park Avenue
New York, New York 10169
Peter Feldman, Esq.
John Bougiamas, Esq.
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PAUL HASTINGS LLP
Attorneys for CarVal Investors UK Limited, as manager of
Assignee of Doral Bank and Doral Financial Corporation
75 East 55 th Street
New York, New York 10022
Luc A. Despins, Esq.
Jodi A. Kleinick, Esq.
Bryan R. Kaplan, Esq.
SECURITIES INVESTOR PROTECTION CORPORATION
Attorneys for Securities Investor Protection Corporation
805 15th Street, N.W., Suite 800
Washington, DC 20005
Josephine Wang, General Counsel
Kenneth J. Caputo, Senior Associate General Counsel
JAMES M. PECK
United States Bankruptcy Judge
Introduction
The contested matter before the Court is the latest in a series of similar proceedings
brought by James W. Giddens (the “Trustee”) to advance the process of case administration by
seeking judicial approval of his determinations that certain categories of claims do not satisfy the
definition of customer claims in this case. The Trustee, in his capacity 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”) to confirm his determination
that claims asserted by counterparties in relation to repurchase agreements do not qualify for
treatment as customer claims under SIPA. The Securities Investor Protection Corporation
(“SIPC”) has submitted its own arguments in support of the Motion.1
1 SIPC is deemed to be a party in interest in all matters arising under a SIPA liquidation proceeding. 15 U.S.C. §
78eee(d).
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Following extensive briefing and argument by the Trustee and the Representative
Claimants (as defined below), the Court agrees with the Trustee’s determination that these claims
are not entitled to customer status and approves that determination based upon the requirement
that cash or securities must be entrusted with a broker-dealer in order to qualify for customer
protection under SIPA. In this instance, the Representative Claimants do not have customer
claims against LBI because their delivery-versus-payment accounts at LBI did not hold any
securities on September 19, 2008, the date of commencement of this case (the “Commencement
Date”), and they are unable to show that the agreements governing the repurchase transactions in
question contemplated the entrustment to LBI of the securities that were transferred under the
terms of the applicable agreements.
Three banks2 that are typical of the class of claimants asserting a disputed right to
customer status (the “Representative Claimants”)3 oppose the Motion, relying primarily upon the
decision of the United States District Court for the District of New Jersey in Cohen v. Army
Moral Support Fund (In re Bevill, Bresler & Schulman Asset Mgmt. Corp.), 67 B.R. 557 (D.N.J.
1986). That New Jersey district court decision held that claims made against a broker-dealer in
2 The banks are Hudson City Savings Bank (“Hudson”); the Federal Deposit Insurance Corporation (“FDIC”), as
receiver of Westernbank Puerto Rico (“Westernbank”); and CarVal Investors UK Limited (“CarVal”), as manager
of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation (collectively, “Doral”).
3 Prior to oral argument on the Motion, the Trustee entered into stipulations (collectively, the “Non-Participant
Stipulation”) that were “so ordered” by the Court with certain claimants (other than the Representative Claimants)
(i) who had submitted one or more customer claims arising out of repurchase and/or reverse repurchase transactions
with LBI that were open as of the Commencement Date, (ii) whose claims had been denied customer treatment by
the Trustee and (iii) who had objected to the Trustee’s determination. Pursuant to the Non-Participant Stipulation,
these so-called Non-Participating Claimants agree, inter alia, that any legal rulings made by this Court or any
appellate court with respect to the Motion shall also apply in any litigation with respect to their claims, unless any
court expressly provides otherwise. See So Ordered Stipulation and Order Regarding the Trustee’s Determinations
of Claims Arising Out of Repurchase and Reverse Repurchase Transactions Entered Into by Non-Participating
Claimants [ECF No. 4623]; So Ordered Stipulation and Order Regarding the Trustee’s Determinations of Claims
Arising Out of Repurchase and Reverse Repurchase Transactions Entered Into by Non-Participating Claimants [ECF
No. 4687]; So Ordered Stipulation and Order Regarding the Trustee’s Determinations of Claims Arising Out of
Repurchase and Reverse Repurchase Transactions Entered Into by Non-Participating Claimants [ECF No. 4703]; So
Ordered Stipulation and Order Regarding the Trustee’s Determinations of Claims Arising Out of Repurchase and
Reverse Repurchase Transactions Entered Into by Non-Participating Claimants [ECF No. 4735]. Certain other
objecting claimants with open repos declined to sign the Non-Participant Stipulation. Trustee Br. Supp. ¶ 14.
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relation to hold-in-custody repurchase agreements were customer claims under SIPA. The
Representative Claimants cite to this precedent as persuasive support for their position, but, as
explained in the discussion section of this Memorandum Decision, Bevill, Bresler involved
securities that actually were being held by the SIPC member firm for the claimants.
That is far different from the current situation. Even if the holding could be applied more
broadly to other types of repo agreements, Bevill, Bresler is not binding precedent and does not
control the outcome here. Importantly, the repo transactions before the Court, by their very
nature and structure, lead directly to the conclusion that the Representative Claimants are entitled
to no more than general creditor claims against the estate. They never entrusted any property
with LBI as their broker-dealer, and that is fatal to establishing customer status. Their account
statements confirm transactions involving repo contracts, but not the retention and holding of any
customer securities or cash. Without the existence of identified property in the hands of LBI, no
customer claim can be made against the estate to recover such property.
Thus, the Motion is comparable to an earlier contested matter in which the Trustee and
SIPC urged the Court to approve the determination that claims relating to so-called TBA
contracts are not customer claims against the LBI estate. See ECF No. 4360. The Court agreed
with the position advocated by the Trustee and SIPC, finding that “without identified property in
the hands of LBI, there can be no claim against the estate for the recovery of such property.” In
re Lehman Brothers Inc., 462 B.R. 53, 57-58 (Bankr. S.D.N.Y. 2011) (the “TBA Decision”).4
The analysis in the TBA Decision with respect to customer property applies equally well
to the claims made by the Representative Claimants. They try to side step the TBA Decision by
4 The TBA Decision dealt with claims relating to so-called TBA (“to be announced”) mortgage-backed securities
and found that (i) the contractual right to acquire such securities was not equivalent to the securities themselves, (ii)
no property was entrusted to LBI or held in customer accounts at LBI, and (iii) as a result, the holders of such
contractual rights did not have customer claims under SIPA.
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stressing the fact that the claimants there never delivered any securities to LBI (and indeed the
TBA contracts related to securities that had not yet been issued), but this is a distinction without
a difference. The simple and unavoidable truth is that the LBI accounts of the Representative
Claimants held no property on the Commencement Date, and that indisputable fact alone is
dispositive. The Representative Claimants are not entitled to customer claims under SIPA
relating to the repurchase transactions in question.
Factual Background
A repurchase transaction (or “repo”) is a single transaction consisting of two related
parts. The first step of the transaction involves a “Seller” who agrees to transfer securities (the
“Purchased Securities”) to a counterparty, the “Buyer,” against the transfer of cash by the Buyer.
The second step is the simultaneous agreement by the Buyer to transfer back the securities to the
Seller on the “Repurchase Date” (a specified future date), against the transfer of cash by the
Seller back to the Buyer on the Repurchase Date. McIsaac Decl.5 ¶ 8.
The market value of the Purchased Securities transferred to the Buyer in the first step of
the transaction generally is higher than the value of the funds transferred to the Seller, with the
difference in value being referred to as the “haircut.” McIsaac Decl. ¶ 9. The funds transferred
back to the Buyer in the second step of the transaction include, in addition to the sum originally
transferred to the Seller, an amount representing a financing charge computed using an agreed
interest rate, also known as a “repo rate.” McIsaac Decl. ¶ 10.
Whether a transaction is called a “repo” or a “reverse repo” is a matter of perspective.
When viewed from the Seller’s perspective, the transaction is called a repo; when viewed from
the Buyer’s perspective, the same transaction is called a reverse repo. McIsaac Decl. ¶ 13;
5 References to “McIsaac Decl.” are to the Declaration of Daniel T. McIsaac in Support of the Trustee’s Motion for
an Order Confirming the Trustee’s Determination of Claims Related to Repurchase Agreements [ECF No. 5050].
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Legotte Decl.6 ¶ 8. The Motion involves transactions that were all reverse repos from LBI’s
perspective, inasmuch as LBI acted as the “Buyer.” Legotte Decl. ¶¶ 8, 15.
The term (i.e., the time period between the date of the initial transfer of securities and the
Repurchase Date) of a repo is fixed by the agreement of the parties. McIsaac Decl. ¶ 12. A
“term” repo has a fixed repurchase date, which may be anywhere from the next day to several
years. An “open” repo has no fixed repurchase date, and either party may terminate the
transaction on demand. McIsaac Decl. ¶ 12; Legotte Decl. ¶ 9.
There are three types of delivery arrangements for repo transactions: (i) bilateral repos, in
which the Seller delivers the Purchased Securities to the Buyer or its agent at the outset of the
transactions against the transfer of cash; (ii) safekeeping or hold-in-custody (“HIC”) repos, in
which the Purchased Securities are not delivered to the Buyer, but rather are placed in an internal
safekeeping account by the Seller, for the Buyer, throughout the duration of the repo; and (iii) tri-
party repos, whereby the Buyer and Seller enter into a contractual arrangement with a third-party
agent who acts as an intermediary between the counterparties. McIsaac Decl. ¶ 16. The repos at
issue in the Motion are bilateral repos. Legotte Decl. ¶¶ 23-26.
As described in more detail below, each of the repo transactions between LBI and the
Representative Claimants was governed by an industry-standard Master Repurchase Agreement
(“MRA”).7 The MRA defines the rights of parties to the transaction and contains provisions
relating to the maintenance of margin, substitution of securities, default remedies, required
disclosures, and other matters. McIsaac Decl. ¶ 19. The details of each particular repo
6 References to “Legotte Decl.” are to the Declaration of Leonard J. Legotte in Support of the Trustee’s Motion for
an Order Confirming the Trustee’s Determination of Claims Related to Repurchase Agreements [ECF No. 5010].
7A Global Master Repurchase Agreement (“GMRA”) is a different industry-standard contract that may also be used
to document the rights and obligations of counterparties to repo transactions. It is closely modeled on the MRA, but
covers different securities. McIsaac Decl. ¶ 17 and n.3. Certain of the objecting claimants (other than the
Representative Claimants) had repo transactions governed by a GMRA. According to the Trustee, the provisions of
the GMRA that are relevant to the Motion are substantially similar to corresponding provisions in the MRA.
Trustee Br. Supp. ¶ 26 n.9.
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transaction, including the purchase and repurchase prices, margin percentage, term, and repo
rate, are set out in separate letter agreements (or “confirmations”). Id. The MRA states that the
transactions between the counterparties constitute a “business and contractual relationship,” and
each party represents and warrants that “it will engage in such transactions as principal.” Foukas
Decl.8 Ex. A1 ¶¶ 10, 12.
The MRA includes specific margin provisions designed to protect both parties with
respect to changes in the value of the Purchased Securities during the term of the repo. McIsaac
Decl. ¶ 20. To ensure that a Buyer is always fully collateralized, the MRA provides that if the
market value of the Purchased Securities should fall below the specified margin percentage, a
“Margin Deficit” is created, and the Buyer can require the Seller to transfer additional securities
(or cash) in order to make up the shortfall. Foukas Decl. Ex. A1 ¶ 4(a). Conversely, to ensure
that the Buyer is not unduly over-collateralized, the MRA provides that if the value of the
Purchased Securities should increase above the specified margin percentage, a “Margin Excess”
is created, and the Seller may then demand the transfer of cash or Purchased Securities to
rebalance the respective positions of the parties. Foukas Decl. Ex. A1 ¶ 4(b).
The MRA also provides that the Buyer is free to use the Purchased Securities for its own
purposes until the Repurchase Date. Foukas Decl. Ex. A1 ¶ 8. Although the Buyer is obligated
to transfer the Purchased Securities back to the Seller on the Repurchase Date, the MRA affords
great latitude to the Buyer pending the date of such transfer stating that
All of Seller’s interest in the Purchased Securities shall pass to Buyer [and] nothing in
this Agreement shall preclude Buyer from engaging in repurchase transactions with the
Purchased Securities or otherwise selling, transferring, pledging or hypothecating the
Purchased Securities.
8 References to “Foukas Decl.” are to the Declaration of Savvas A. Foukas in Support of the Trustee’s Motion for an
Order Confirming the Trustee’s Determination of Claims Related to Repurchase Agreements [ECF No. 5008].
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Foukas Decl. Ex. A1 ¶ 8. Accordingly, the MRA does not impose any obligation on the Buyer
to segregate the Purchased Securities or otherwise hold them for the Seller.
The MRA also sets forth the rights of the parties in the event of a default by either party
prior to the Repurchase Date. An “Act of Insolvency” constitutes an “Event of Default.” Foukas
Decl. Ex. A1 ¶ 11(d)(ii). When an Act of Insolvency occurs in relation to the Buyer, the Seller is
deemed to have declared an Event of Default and the Repurchase Date is accelerated to occur
immediately. The Seller, in its discretion, may either purchase replacement securities or be
deemed to have purchased replacement securities. Foukas Decl. Ex. A1 ¶ 11(d)(ii). The
defaulting Buyer is liable to the Seller for any excess of the price paid or deemed paid for
replacement securities over the repurchase price for the Purchased Securities that were not
delivered to the Seller. Foukas Decl. Ex. A1 ¶ 11(e).
Certain Facts Regarding the Hudson Repos
Hudson had a relationship with LBI dating back to 1983, and was a customer of LBI’s
Middle Markets Desk. Kranz Decl.9 ¶¶ 7-8; Sylvin Decl.10 ¶¶ 3-4. LBI served as Hudson’s
investment banker and broker-dealer. Kranz Decl. ¶ 8. LBI, through its Middle Markets Desk,
eventually offered Hudson a long-term structured repurchase agreement as a means to finance
Hudson’s acquisition of a position in highly liquid mortgage-backed securities. Kranz Decl. ¶¶
8-9; Sylvan Decl. ¶¶ 3-5.
Hudson, LBI and Lehman Commercial Paper Inc. entered into two repo transactions
dated September 7, 1999 and September 13, 1999, each in the amount of $50 million. Kranz
Decl. ¶ 17. The repos were governed by an industry-standard MRA (the “Hudson MRA”) and
9 References to “Kranz Decl.” are to the Declaration of James C. Kranz in Support of Hudson City Savings Bank’s
Response to Trustee’s Motion to Confirm Notice of Determination of Claim [ECF No. 5240].
10 References to “Sylvin Decl.” are to the Declaration of Allison Sylvin in Support of Hudson City Savings Bank’s
Response to Trustee’s Motion to Confirm Notice of Determination of Claim [ECF No. 5241].
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were memorialized by letter agreements dated September 9, 1999 and September 14, 1999
(collectively, the “Hudson Confirmations”). Id.; Foukas Decl. Exs. A1-A3. On February 7,
2003, LBI and Hudson executed a “Structured Funding Modification” to the Hudson MRA,
which incorporated the Hudson MRA and the Hudson Confirmations and set forth the terms of
two long-term repo transactions, each having a value of $50 million. Foukas Decl. Ex. A4.
Under the terms of the Hudson MRA, Hudson transferred $100 million of securities, plus
additional securities comprising the “Seller’s Margin Amount.” In turn, LBI transferred $100
million to Hudson and agreed to return the securities on the maturity date or on demand upon the
occurrence of certain events. Kranz Decl. ¶¶ 18-19. LBI could make a call for additional margin
in cash or securities if the market value of the securities transferred by Hudson fell below a
Seller’s Margin Amount of 105%. Similarly, if the securities increased in value above the
Seller’s Margin Amount, Hudson could demand transfer of any excess margin collateral. Foukas
Decl. Ex. A1, ¶ 4. Hudson entered into the repos with the expectation that it owned the
underlying securities and that they would be returned. Kranz Decl. ¶ 13.
Certain Facts Regarding the Westernbank Repos
On February 23, 1998, Westernbank executed an industry-standard Master Repurchase
Agreement with LBI (the “Westernbank MRA”). Foukas Decl. Ex. B-1. In August 2001 and
January 2002, LBI and Westernbank entered into three11 separate long-term structured repo
transactions, each with a term of 15 years. Each of these transactions was memorialized by a
confirmation letter. Maldonado Decl.12 ¶ 12, Exs. D, E, F. Westernbank’s primary purpose for
investing in agency securities through its repo transactions with LBI was to receive the fixed
coupon income that was paid by the issuer. Maldonado Decl. ¶14.
11 The counterparty for one of these repo transactions was Westernbank’s International Division. Maldonado Decl.
¶ 12.
12 References to “Maldonado Decl.” are to the Declaration of Freddy Maldonado [ECF No. 5178].
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Pursuant to the Westernbank MRA, the value of the securities purchased by LBI from
Westernbank needed to be fixed at a set percentage in excess of the amount due on the
repurchase date. Maldonado Decl. ¶ 15. If the market value of the securities decreased, then
Westernbank was subject to a margin call from LBI, and would be required to deliver additional
securities to LBI. If the market value of the securities increased, LBI would be obligated to
deliver securities back to Westernbank. Id. At all relevant times, Westernbank had the absolute
right to demand that LBI return to Westernbank any security subject to these structured
repurchase transactions, in which event Westernbank would have to provide substitute securities
to LBI. Maldonado Decl. ¶18. Westernbank considered the securities that it transferred to LBI
as its own and treated them accordingly. Maldonado Decl. ¶ 19.
Certain Facts Regarding the Doral Repos
Doral had a long-term relationship with LBI as a broker-dealer and regularly purchased
and sold securities through LBI. Torres Decl.13 ¶ 10. Between January 2000 and May 2001, LBI
and Doral entered into six repo transactions, each governed by an industry-standard Master
Repurchase Agreement (collectively, the “Doral MRA”) and memorialized by a confirmation.
Foukas Decl. Exs. C1-C4. The repo transactions governed by the Doral MRA involved the sale
of securities by Doral to LBI, with the simultaneous agreement by LBI to resell the securities to
Doral at a fixed price on a date to be determined. Torres Decl. ¶ 5. Throughout the term of each
of its repo transactions with LBI, Doral held the securities transferred to LBI as assets on its
balance sheet; the matching obligations to repurchase these securities on their respective
repurchase dates were recorded as corresponding liabilities. Torres Decl. ¶11.
13 References to “Torres Decl.” are to the Declaration of Maricarmen Logroño Torres [ECF No. 5179].
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Certain facts regarding LBI’s account relationship with the Representative Claimants
At least one separate account bearing a unique account number was established for each
person or entity having dealings with LBI with respect to financial transactions and services.
Legotte Decl. ¶ 18. LBI’s system of accounts distinguished between custodial, no-lien
(“safekeeping” or “segregated”) accounts in which LBI held assets for its customers that were
segregated from securities available for use by LBI in its proprietary business, and delivery-
versus-payment, or DVP, accounts in which transactions were recorded but no cash or property
was held in the account. Legotte Decl. ¶ 19.
In the case of DVP accounts, on the settlement date for any particular transaction, LBI
would transfer any cash, securities or other property due to the client in exchange for a
simultaneous cash transfer or delivery of property by the client. Id. Holders of DVP accounts
designated the destination of any payment or delivery by LBI (usually a third-party financial
institution) by means of standing instructions maintained in LBI’s records. Legotte Decl. ¶ 20.
No cash or property would be held in DVP accounts. Legotte Decl. ¶ 19.
Each of the Representative Claimants opened a DVP account. Legotte Decl. Exs. 7-11
(account opening documents reflecting an “x” or check mark in a box corresponding to
“DVP”). 14 In connection with their DVP accounts, each of the Representative Claimants
provided LBI with standing instructions designating a clearing agent to receive any transfers of
securities or cash –Westernbank designated Citibank as its clearing agent, and each of Doral and
Hudson designated the Bank of New York. Legotte Decl. ¶ 23, Exs. 1-5.
Any payment of cash or delivery of securities to each of the Representative Claimants
would be transferred to or from the designated third-party financial institution. Legotte Decl. ¶
14 Westernbank opened accounts for Westernbank Puerto Rico and Westernbank International. Legotte Decl. Exs.
8-9. Doral opened accounts for Doral Bank and Doral Financial Corp. Legotte Decl. Exs. 10-11.
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23, Exs. 1-5. Accordingly, the transaction activities for the Representative Claimants were all
recorded in their respective DVP accounts, but LBI held no property in those accounts. Each of
the Representative Claimants regularly received a client statement from LBI that did not include
a “Portfolio Details” section, an indication that LBI did not hold any securities or other assets for
them. Legotte Decl. ¶¶ 40, 44; Exs. 46, 57.
As was expressly permitted under the MRA, LBI did not hold any of the Purchased
Securities while the repo transactions were open and routinely used the Purchased Securities
underlying the applicable reverse repo transactions for LBI’s own purposes, including repo
transactions or collateral pledges (in exchange for cash or borrowed securities) involving other
counterparties. Legotte Decl. ¶ 13. LBI’s stock record, maintained in accordance with SEC
regulations, reflects that each of the Purchased Securities was transferred by LBI to other
counterparties in repo transactions or collateral pledges. 17 C.F.R. § 240.17a-3(a)(5); Legotte
Decl. ¶¶ 25, 33-35; Exs. 13-45, 13-A-45-D. LBI’s records also show that none of the Purchased
Securities was held in safekeeping on the Commencement Date or at any other time. Legotte
Decl. ¶¶ 33-35. As of the Commencement Date, the majority of the Purchased Securities was in
the possession of third parties.15 Legotte Decl. ¶¶ 36-37, Exs. 13-45.
Background Regarding Determination of Claims by the Trustee
Each of the Representative Claimants filed a timely customer claim. Kranz Decl. Ex. G
(Hudson); Feldman Decl.16 Exs. 36-37 (Westernbank); Torres Decl. Ex. 1 (Doral). The Trustee
15 On the Commencement Date, positions in certain CUSIPs underlying LBI’s repo transactions with Doral were in
LBI’s main operating account at Chase. Legotte Decl. ¶ 36, Exs. 22, 24, 26. This account contained securities that
LBI could use in its proprietary business. Legotte Decl. ¶ 36. After the Commencement Date, Chase notified the
Trustee that it had seized these securities, along with other securities in the same account, to cover an overdraft in
LBI’s main operating account at Chase. Id.
16 References to “Feldman Decl.” are to the Declaration of Peter Feldman in Support of Memorandum of Law of (I)
The FDIC, as Receiver of Westernbank Puerto Rico and (II) CarVal Investors UK Limited, as Manager of Assignee
of Doral Bank and Doral Financial Corporation, in Opposition to Trustee’s Motion for an Order Confirming the
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responded by timely serving on each Representative Claimant a Notice of Trustee’s
Determination of Claim (i) denying each claim for customer treatment, (ii) stating his intent to
treat each claim as a general unsecured claim and (iii) reserving the right to object to such
general unsecured claim at a later date. Each of the Representative Claimants filed an objection
to the Notice of Trustee’s Determination of Claim. [ECF Nos. 1677 (Hudson); 2494
(Westernbank); 2495 (Westernbank); 1709 (Doral); 1710 (Doral)].
The parties have worked together cooperatively in developing a schedule for the
submission of declarations and briefs. These submissions have enabled the Court to resolve the
above objections of the Representative Claimants on the basis of an agreed record.
Discussion
SIPA protection extends only to those persons or entities that can satisfy the definition of
“customer” under SIPA. The term “customer” is a “short-hand designation for those eligible
under SIPA to receive special protection … .” In re Stalvey & Assocs., 750 F.2d 464, 468 (5th
Cir. 1985). This right to special protection in a SIPA proceeding should be construed narrowly
in light of the statutory purpose. See, e.g., In re Omni Mut., Inc., 193 B.R. 678, 680 (S.D.N.Y.
1996) (citations omitted) (noting that “customer” is a “term of art” that “should be construed
narrowly”). The burden is on the claimant to prove entitlement to SIPA protection. Mishkin v.
Siclari (In re Adler, Coleman Clearing Corp.), 277 B.R. 520, 557 (Bankr. S.D.N.Y. 2002).
As of the Commencement Date, the applicable definition of the term “customer” as used
in SIPA read as follows:
any person (including any person with whom the debtor deals as principal or agent) who
has a claim on account of securities received, acquired, or held by the debtor in the
ordinary course of its business as a broker or dealer from or for the securities accounts of
such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to
Trustee’s Determination of Claims Relating to Repurchase Agreements Between LBI and Westernbank Puerto Rico
and Doral Bank and Doral Financial Corporation [ECF No. 5176].
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purchases, as collateral, security, or for purposes of effecting transfer. The term
"customer" includes any person who has a claim against the debtor arising out of sales or
conversions of such securities, and any person who has deposited cash with the debtor for
the purpose of purchasing securities, but does not include —
(A) any person to the extent that the claim of such person arises out of transactions with a
foreign subsidiary of a member of SIPC; or
(B) any person to the extent that such person has a claim for cash or securities which by
contract, agreement, or understanding, or by operation of law, is part of the capital of
the debtor, or is subordinated to the claims of any or all creditors of the debtor,
notwithstanding that some ground exists for declaring such contract, agreement, or
understanding void or voidable in a suit between the claimant and the debtor.
SIPA § 78lll(2).17
Thus, the definition relates customer securities received, acquired or held “for
safekeeping” by the broker-dealer in the ordinary course of business or to cash deposited for the
purpose of purchasing securities. Consistent with this definition, it has been held that “[a]n
investor is entitled to compensation from the SIPC only if he has entrusted cash or securities to a
broker-dealer who becomes insolvent; if an investor has not so entrusted cash or securities, he is
not a customer and therefore not entitled to recover from the SIPC trust fund.” In re Brentwood
Secs., Inc., 925 F.2d 325, 327 (9th Cir. 1991). “[T]he ‘critical aspect of the ‘customer’ definition
is the entrustment of cash or securities to the broker-dealer for the purpose of trading securities,’”
In re Bernard L. Madoff Inv. Secs. LLC, 654 F.3d 229, 236 (2d Cir. 2011) (emphasis omitted)
(quoting Appleton v. First Nat’l Bank of Ohio, 62 F.3d 791, 801 (6th Cir. 1995)).
The Representative Claimants point to certain facts that they contend “evince”
entrustment – that (i) they delivered the Purchased Securities to LBI with the intention that such
securities would be returned on a date certain, and (ii) they retained all benefits of ownership of
the Purchased Securities. Westernbank/Doral Br. Opp’n 29. These contractual expectations and
17 Subsequent to the Commencement Date, the definition of "customer" under SIPA was amended by the Dodd-
Frank Wall Street Reform and Consumer Protector Act of 2010, 12 U.S.C. §§5301 et seq. The amended definition
is not applicable to the issues raised by the Motion.
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retained interests are insufficient by themselves to establish the key possessory elements that are
needed to establish entrustment. There is no substitute for actual possession by the broker-
dealer. Entrustment simply requires “receipt, acquisition or holding of the securities by the
Debtor in the evident sense required by the Act – that is, an actual possession – so as to ground a
protected ‘net equity’.” SEC v. Kenneth Bove & Co., 378 F. Supp. 697, 700 (S.D.N.Y. 1974).
The Representative Claimants have no good way to fill in this missing possessory
requirement of the definition, and the facts are not helpful. LBI did not hold the securities and
under the relevant documentation had no obligation to do so. The MRA specifically disclaims
any obligation of a broker-dealer as Buyer or Seller to hold property for a counterparty, but
expressly permits the Buyer to engage in “selling, transferring, pledging or hypothecating the
Purchased Securities … .” Foukas Decl. Ex. A1 ¶ 8. The Representative Claimants recognize
that LBI did not (and was not required to) segregate securities it received from them, that LBI
subsequently rehypothecated the securities, and that their DVP accounts were empty. Hudson
Br. Opp’n 19-25, 33; see Westernbank/Doral Br. Opp’n 9, 28, 56; Foukas Reply Decl.18 Ex. F
(Maldonado Tr. 74:5-76:2) (agreeing that “Portfolio Detail” section of LBI Client Statement
reflects “assets actually held at Lehman as of the last day of the month”).
The Representative Claimants submit that the fact that their accounts at LBI were DVP
accounts does not preclude a finding that they entrusted property to LBI. Hudson Br. Opp’n 22-
23 (“DVP merely denotes a form of settling a customer’s securities account”);
Westernbank/Doral Br. Opp’n 46 (“DVP merely describes the means by which trades are
settled”). While it is true that mere labeling of the account as DVP does not determine
“customer” status under SIPA, in this instance the DVP accounts were structured and utilized in
18 References to “Foukas Reply Decl.” are to the Reply Declaration of Savvas A. Foukas in Support of the Trustee’s
Motion for an Order Confirming the Trustee’s Determination of Claims Related to Repurchase Agreements [ECF
No. 5345].
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a manner that enabled institutions other than LBI to hold the securities that were purchased from
the Representative Claimants. The accounts were not possessory by their very nature, and that
defeats customer status. “[T]he absence of actual receipt, acquisition or possession of the
property of a claimant by the brokerage firm under liquidation has been held to be dispositive
against a claim to participation in the coverage under the Act extended by SIPC.” Kenneth Bove,
378 F. Supp. at 700.
Nonetheless, the Representative Claimants argue that there is more to entrustment than
physical possession in a brokerage account and that the contractual obligation to return the
securities constitutes a kind of deemed entrustment. They submit that the commercial
relationship of the parties, the terms of the MRA, the electronic linking by LBI of the Purchased
Securities to the Representative Claimants’ accounts and industry practice, when considered
together, are sufficient to prove entrustment and give them the rights under SIPA that are
reserved for customers. See Westernbank/Doral Br. Opp’n 29 (“[t]he fact that the same
securities were required to be returned and that the [Representative] Claimants retained all
incidents of investment (including the issuer’s payment of coupon interest and principal) evinces
entrustment”); Hudson Br. Opp’n 28 (“[t]he Hudson MRA provides that, regardless of how LBI
utilized LBI’s securities, ‘no such transaction shall relieve Buyer of its obligations to transfer
Purchased Securities to Seller pursuant to Paragraph 3, 4 or 11 hereof’”); Westernbank/Doral Br.
Opp’n 17 (“LBI linked the Purchased Securities to the [Representative] Claimants and their
Accounts on its books”); Hudson Br. Opp’n 28 (“LBI’s internal electronic documents always
linked Hudson’s Securities to Hudson’s account”).
The contractual duty of LBI to return in kind the Purchased Securities to the
Representative Claimants is not the same as actual possession by LBI. It is not plausible to
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expand the meaning of possession beyond its literal interpretation and to suggest that the
hypothecation of securities to third parties can be disregarded. Such efforts to elevate the claims
of the Representative Claimants to customer status are unpersuasive and inconsistent with a
narrow reading of the SIPA definition of customer. A contractual obligation by LBI to return
securities is no substitute for an account statement that includes an inventory of securities
actually held by a broker-dealer for its customer. The Representative Claimants have no such
account statements, and there is no way to ignore or navigate around this missing possessory
requirement for customer status.
Arguments regarding electronic linkage of the Purchased Securities to the Representative
Claimants are of no value in assessing whether there has been entrustment of the securities to
LBI. The fact that payments of principal and interest were made to the Representative Claimants
may be indicative of a retained ownership interest in the securities, but such a retained interest
has no significance whatsoever in deciding whether repo counterparties may assert customer
claims. The right to receive payments in connection with securities that were being held by third
parties as permitted by the terms of the MRA is irrelevant to the question of customer status or
the right to SIPA protection in this case.
The Representative Claimants also make the specious argument that because the
Purchased Securities were received and acquired by LBI at the origination of the repo
transaction, “it is not necessary that they also were ‘held’” by LBI on the Commencement Date.
Westernbank/Doral Br. Opp’n 25 n. 20. That is simply not true, and their assertion turns a blind
eye to the reality of onward movement of the securities. They argue that hypothecation has no
impact upon entrustment that allegedly vested at the outset of the repo transactions. See also
Hudson Br. Opp’n 46 (“entrustment was not affected by LBI’s right to hypothecate Hudson’s
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Securities”). However, the Representative Claimants are not free to disregard the legal
significance of facts that existed on the Commencement Date. As noted earlier in this decision,
it is undisputed that the Purchased Securities were either (i) hypothecated or (ii) held by LBI in
its own operating account for use in its proprietary business, and that no property was being held
for the Representative Claimants on the Commencement Date. The analysis ends there. The
Representative Claimants have no grounds to argue that their claims somehow should relate back
to an earlier date before their securities were hypothecated to third parties or transferred by LBI
into its operating account. See In re Adler, Coleman, 195 B.R. at 270 (explaining that “[a]
customer’s account is valued as of the date the SIPA liquidation is commenced”).
The various arguments made by the Representative Claimants fail at the most
fundamental level: their account statements with LBI confirm transactions but not the
entrustment of any property. The very same analysis appears in the TBA Decision where the
Court considered LBI client statements that listed transactions but reflected that no property was
being held. See TBA Decision, 462 B.R. at 57 (noting that claimants’ “account statements
confirm transactions involving TBA contracts but not the holding of any customer securities or
cash”).
Although the claimants in the TBA Decision never delivered any property to LBI, that
factor does not limit the application of this relevant decision to the current dispute. The TBA
Decision found that the customer accounts at LBI were used to facilitate trading activity but “did
not involve the retention by the broker-dealer of customer property that is a necessary part of the
definition of a customer claim.” Id. The Court ultimately concluded that “[s]implistically and
narrowly, without identified property in the hands of LBI, there can be no claim against the
estate for the recovery of such property.” Id. at 57-58. That statement applies here with equal
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force. Because the accounts of the Representative Claimants held no property, there can be no
customer claim for the recovery of any property.
The claims at issue against LBI are transactional in nature and arise out of the contractual
right, upon fulfillment of the terms of the MRAs, to reacquire the Purchased Securities that
underlie the repo transactions upon repayment of principal, together with interest. The rights to
the Purchased Securities are governed by the contractual relationship that exists between the
Representative Claimants and LBI under their respective MRAs. As a result, their claims against
LBI are breach of contract claims, not customer claims to recover their securities.19 As noted in
the TBA Decision, “such claims are not entitled to protection under SIPA.” TBA Decision, 462
B.R. at 62 (citations omitted); see also In re Klein, Maus & Shire, Inc., 301 B.R. 408, 421
(Bankr. S.D.N.Y. 2003) (“[b]ecause claims for damages do not involve the return of customer
property entrusted to the broker they are not the claims of ‘customers’ under SIPA”); In re MV
Securities, Inc., 48 B.R. 156, 160 (Bankr. S.D.N.Y. 1985) (citation omitted) (“SIPA does not
protect customer claims based on fraud or breach of contract”).
Notwithstanding the powerful logic of this conclusion, the Representative Claimants
place considerable reliance on Bevill, Bresler in their effort to show that they qualify for
customer protection under SIPA. In Bevill, Bresler, the District Court denied the motion of the
SIPA trustee who argued that claimants involved in certain repo transactions were not
“customers” under SIPA because the repos and reverse repos at issue were collateralized loans.
Although the Court in Bevill, Bresler determined that the claimants were customers, the
circumstances were materially different from those presented here. Significantly, the trustee’s
19 The Court recently considered a similar question in FirstBank Puerto Rico v. Barclays Capital Inc., Adv. Proc.
No. 10-04103(JMP), 2013 Bankr. LEXIS 1938 (Bankr. S.D.N.Y. May 10, 2013). In that decision, the Court denied
the alleged right to recover certain identified securities that were the subject of a repo transaction, and held that the
failure to return such securities is a breach of contract claim. Id. at *26-27.
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motion in Bevill, Bresler related to a group of test cases, all involving HIC repos in which the
SIPC member firm actually was holding property for the claimants. Therefore, although the case
may be cited for the proposition that a repo counterparty under certain circumstances may have a
customer claim under SIPA, the facts are entirely distinguishable from the contested matter now
before the Court.
In an HIC repo, the securities that are the subject of the transaction are placed in a
safekeeping account. LBI did not hold any securities or cash for the Representative Claimants,
and the MRAs did not contemplate such a structure. In Bevill, Bresler, the Court focused on the
custodial arrangements that are not present here, commenting that “the securities were placed in
safekeeping where they remained on the filing date.” 67 B.R. at 600; see also id. at 570
(contrasting “delivery repo transactions,” where the dealer transfers the securities to the repo
participant or its agent at the outset of the transaction, with “non-possessory or safekeeping repo
transactions,” where the dealer retains the securities for the account of the repo participant).
Because of the obvious structural differences, the ruling in Bevill, Bresler is not persuasive
authority with respect to the question presented.
The parties have raised a number of additional points that are not material to the Court’s
decision. The Representative Claimants submit that (i) repo transactions are not secured loans
and, therefore, the Second Circuit’s line of cases holding that secured loans are not entitled to
customer status are not applicable and (ii) as customers, they have claims for net equity. The
Trustee and SIPC argue that to afford the Representative Claimants “customer” protection and
the corresponding right to share in the fund of customer property would significantly dilute, or
reduce, the recovery by customers who actually entrusted cash or securities to LBI. They assert
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such an outcome would be detrimental to “customers,” and would not provide the protection
envisioned by Congress.
Regardless of their merit, the Court does not need to address these various collateral
issues. The central thesis of this decision is sufficient to resolve the dispute before the Court: in
order to satisfy the definition of “customer” under SIPA, the broker-dealer must have received,
acquired or held securities or cash for the purpose of purchasing securities. Actual entrustment
of property (securities or cash) is a necessity, and the inability to show such entrustment makes it
impossible to prove customer status under SIPA.
Conclusion
Because the Representative Claimants did not entrust any customer property to LBI, they
are unable to prove any right to customer protection under SIPA. Consequently, the Trustee is
correct in his determination that the repo claims of the Representative Claimants are not
customer claims against LBI. Accord TBA Decision, 462 B.R. at 63. The Motion is granted, and
the Trustee is directed to submit an order consistent with this Memorandum Decision.
SO ORDERED.
Dated: New York, New York
June 25, 2013
/s/ James M. Peck
___________________________
Honorable James M. Peck
United States Bankruptcy Judge
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