Securities Investor Protection Corp. v. Lehman Bros.

Citations: 433 B.R. 127; 63 Collier Bankr. Cas. 2d 1513; 2010 Bankr. LEXIS 1623; 53 Bankr. Ct. Dec. (CRR) 62; 2010 WL 2163358Docket: 14-36125

Court: United States Bankruptcy Court, S.D. New York; June 1, 2010; Us Bankruptcy; United States Bankruptcy Court

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James W. Giddens, as Trustee for the liquidation of Lehman Brothers Inc. (LBI) under the Securities Investor Protection Act (SIPA), filed a motion to uphold his determination regarding the claim of Fifth Third Structured Large Cap Plus Fund (Fifth Third) and to expunge Fifth Third's objection. The key issue is the appropriate date for valuing Fifth Third's claim related to closing short positions in its LBI account, which significantly affects the claim amount due to market fluctuations. The Trustee contends that the valuation date should be the filing date of the LBI liquidation, in accordance with SIPA's guidelines.

Fifth Third disputes this, asserting its status as a financial participant entitles it to a different treatment under the Bankruptcy Code, particularly following amendments made in 2005. Fifth Third argues that its claim should be valued as of March 11, 2009, the date of a limited settlement agreement with the Trustee, rather than the filing date. It claims that the Bankruptcy Code's provisions protect financial participants from the automatic stay and clarify their rights, thus allowing them to value their claims based on the termination date of their securities contracts with LBI, as per Section 562 of the Bankruptcy Code.

Additionally, Fifth Third states that its claim should not be classified as an ordinary customer claim under SIPA due to the nature of the agreements for its short sale transactions, which involved a third party holding borrowed securities and margin payments in a fiduciary capacity. The Court heard arguments on this matter during a hearing on February 25, 2010, and reserved its decision.

The Court affirms that the liquidation date of Lehman Brothers Inc. (LBI), September 19, 2008, is the definitive date for determining claims related to Fifth Third's short positions, consistent with the Securities Investor Protection Act (SIPA). The Court grants the Trustee's motion and denies Fifth Third's objection. LBI's liquidation was initiated following Lehman Brothers Holdings Inc.'s chapter 11 filing on September 15, 2008, and the subsequent Liquidation Order confirmed the need for SIPA protections for LBI's customers and appointed a Trustee to manage the liquidation. Fifth Third, as a registered investment company, had entered into a Prime Brokerage Customer Agreement with LBI and established a Special Custody Account with State Street Bank, granting LBI a security interest in that account. Fifth Third held short positions in this account, requiring margin posting based on the value of the borrowed securities, marked to market daily. The margin was calculated on a net basis, aligning with a "master netting agreement" under the Bankruptcy Code. The Trustee later issued protocols regarding the treatment of prime brokerage arrangements, specifying that customer accounts, including short positions, would be closed out as of September 19, 2008, based on market prices.

Fifth Third attempted to transfer its short positions to another prime broker following the Superseding Protocol, but the Trustee rejected any transfers not compliant with this protocol. On January 30, 2009, Fifth Third filed a customer claim with SIPC, requesting the Trustee to (a) accept cash equivalent to the market value of its short positions, (b) close out the short positions at market values as of the tender date, and (c) allow State Street to release excess margin from the Special Custody Account. A Limited Settlement Agreement was reached on March 12, 2009, placing in escrow the difference between the values needed to close out the short positions on two relevant dates: September 19, 2008 (SIPA filing date) and March 11, 2009 (tender date), amounting to $18,179,102.19. The Disputed Amount remains in escrow pending court resolution, while the value of the short positions as of March 11, 2009, has been transferred to the Trustee, and remaining assets from the Special Custody Account were released to Fifth Third. 

On June 23, 2009, the Trustee determined that Fifth Third's claim was allowed for the value of cash and securities as of September 19, 2008, but denied concerning the Disputed Amount. Fifth Third filed an objection to this determination on July 21, 2009. The court must now reconcile conflicting provisions of SIPA and the Bankruptcy Code. The Trustee emphasizes the SIPA definition of "net equity," requiring calculations based on the filing date, while Fifth Third argues for using Section 562 of the Bankruptcy Code, which focuses on the date of rejection or termination for damage calculations. Additionally, the court must first determine if the assets in the Special Custody Account qualify as "customer property," which affects the claims process under SIPA. Fifth Third contends that its net equity calculation should not be based on the filing date since the assets were segregated and held by a third-party custodian, asserting that the Disputed Amount was never part of the debtor's customer property pool. However, the court notes Fifth Third's prior characterization of these assets as "customer property" in its claim.

The Special Custody Agreement is integral to the prime brokerage services provided by LBI to Fifth Third, facilitating Fifth Third's short selling strategies. Assets held by a custodian in this interconnected relationship qualify as "customer property" under SIPA, which includes cash and securities held for a debtor's accounts. The Court determines that the Disputed Amount is classified as "customer property" since the assets in the Special Custody Account were under LBI's control. The Court next addresses the appropriate date for assessing the market value of securities needed to close Fifth Third's short positions, noting that SIPA mandates the calculation of "net equity" based on the debtor's records as of the filing date.

Fifth Third argues that the correct valuation date is March 11, 2009, referencing amendments to the Bankruptcy Code and SIPA that permit financial participants to net positions without breaching the automatic stay. Specifically, Section 562 states that damages for rejected or terminated securities contracts are assessed as of the date of rejection or termination. Additionally, Section 561 protects Fifth Third's rights under its securities contracts, which should not be affected by LBI's SIPA liquidation. However, March 11, 2009, is pertinent only due to the Trustee's consent in the Limited Settlement Agreement, allowing State Street to close Fifth Third’s short positions. Without this consent, Fifth Third could not direct State Street to close these positions independently. Thus, the pre-SIPA arrangements did not grant Fifth Third the authority to act without LBI's consent, complicating its reliance on the safe harbor provisions for terminating the relevant securities contracts.

Fifth Third's claim to be a specially protected financial participant is undermined by its failure to enter into a Limited Settlement Agreement with the Trustee before attempting to act on the provisions it cites. The rights under the safe harbor provisions of the Bankruptcy Code were not freely exercisable and are subject to contractual limitations, limiting their value in claiming the Disputed Amount and differentiating itself from other LBI customers. Consequently, Fifth Third's arguments regarding sections 561 and 562 of the Bankruptcy Code are ineffective. Despite amendments to SIPA in conjunction with BAPCPA, the definition of net equity remains unchanged, requiring that customer net equity claims be valued as of the filing date. While financial participants can exercise their safe harbored rights, the 2005 Amendments did not create a distinct regime for calculating amounts in SIPA proceedings or establish a new class of specially protected parties. The Court must defer to SIPA's provisions, emphasizing that any Bankruptcy Code language inconsistent with SIPA is inapplicable. Therefore, Fifth Third's reliance on alternative valuation dates is inconsistent with SIPA. The objection to the Trustee's claim determination is overruled, with the operative date for resolving claims to the Disputed Amount set as September 19, 2008. The Trustee is instructed to submit an order consistent with this decision. Additionally, Fifth Third's January 6, 2010 Motion for Summary Judgment is deemed procedurally improper and is struck from the record due to violations of established protocols.

Fifth Third's Memorandum opposing the SIPC Trustee's motion will not be considered by the Court if it introduces new facts not previously agreed upon in the Stipulation of Facts, which was ordered by the Court on November 5, 2009. The Court will, however, include the July 2, 2007 Special Custody Agreement among State Street Bank, Fifth Third, and LBI as part of the record. A letter from Fifth Third's counsel, submitted on March 1, 2010, addressing an issue raised by the Court during a hearing was not considered, as it did not pertain to the relevant issues of the case. All factual reliance in this decision is based on the Stipulation of Facts. Under SIPA, a "customer" is defined broadly, and since Fifth Third is a party to a Prime Brokerage Customer Agreement with LBI, has filed a "customer" claim, and the Court has determined that the Disputed Amount is customer property, Fifth Third qualifies as a customer of LBI regarding this amount.