Court: United States Bankruptcy Court, D. New Jersey; April 23, 2013; Us Bankruptcy; United States Bankruptcy Court
The Court, presided over by Bankruptcy Judge Rosemary Gambardella, is addressing the Motions to Dismiss filed by Defendants Vining Sparks IBG, L.P., Vining Sparks, and Newbridge Securities Corp. against Adversary Complaints brought by Edward P. Bond, the Liquidating Trustee for Debtors U.S. Mortgage Corp. and CU National Mortgage. Additionally, the Court is considering the Trustee’s Application for permission to file an Amended Complaint in the related Adversary Proceeding No. 11-1212. A hearing occurred on December 1, 2011, leading to the Court's findings of fact and conclusions of law.
U.S. Mortgage, a licensed mortgage banker controlled by president and shareholder Michael J. McGrath, and its wholly-owned subsidiary CU National, also operated by McGrath, are alleged by the Trustee to be alter egos of McGrath. Prior to CU National's petition date, the Debtors reportedly held brokerage accounts with the Defendants. U.S. Mortgage was licensed as a seller and servicer of loans for Fannie Mae and engaged in processing and servicing loans for credit unions, with loan proceeds maintained in segregated accounts.
The Trustee asserts that McGrath orchestrated extensive fraudulent practices, including misusing loan proceeds to address cash flow issues and delaying the remittance of Fannie Mae loan proceeds to credit unions, with delays escalating from short periods to over two years. These actions were allegedly part of a broader scheme of financial misconduct.
U.S. Mortgage, under McGrath's direction, engaged in fraudulent activities involving the sale of loans serviced by CU National, including misrepresentation of McGrath's authority and execution of false assignments. They allegedly sold over $20 million in loans to Fannie Mae that were not serviced by the Debtors, modifying the loan servicing system to obscure this transaction. McGrath also used Debtors' funds for various investments to cover operational expenses and hide fraudulent actions. The Trustee claims that the Debtors were significant revenue generators for brokerage firms, allowing them to bypass standard trading regulations. On June 11, 2009, McGrath was charged with a criminal conspiracy resulting in over $100 million in losses, related to the fraudulent sale of Credit Union Loans to finance U.S. Mortgage's operations and McGrath's personal investments. The U.S. Attorney alleged that McGrath directed employees to create false accounting records to conceal over $100 million in fund transfers. McGrath pled guilty to these charges the same day. The Trustee's complaints also identify Bill Thompson and John Slipek as account representatives from Vining Sparks and Newbridge Securities, respectively, who assisted McGrath. U.S. Mortgage filed for Chapter 11 bankruptcy on February 23, 2009, followed by CU National on April 1, 2009.
The chapter 11 cases of the Debtors were administratively consolidated by court order on April 13, 2009, following the appointment of the Unsecured Creditors’ Committee on March 13, 2009. The Debtors’ Third Amended Joint Plan of Liquidation was confirmed on October 26, 2009, and the cases were substantively consolidated for post-confirmation purposes effective the same date. Anthony R. Calascibetta was appointed as Liquidating Trustee on November 20, 2009, and subsequently, Edward P. Bond, CPA, was appointed as the Substitute Liquidating Trustee on February 1, 2012.
On February 22, 2011, the Trustee initiated nine adversary complaints against various financial institutions, including Newbridge Securities Corp., a Florida-based securities broker-dealer. The Trustee alleges that Newbridge, aware of fraudulent schemes orchestrated by McGrath, provided services to both McGrath and the Debtors, including facilitating security transactions. John Slipek, an employee of Newbridge, is identified as having a close relationship with McGrath, which included McGrath following Slipek to different brokerage firms. The Trustee claims that McGrath was under the influence of Xanax, which Newbridge’s agents were aware of, and that the Debtors delegated discretionary trading authority to Newbridge, which owed a fiduciary duty to them while earning significant commissions from their trades.
The Trustee asserts that Newbridge received transfers totaling at least $1 million on October 28, 2008, among other unspecified amounts, for purchasing securities or paying commissions. It is alleged that Newbridge and its agents knowingly ignored evidence that these transfers were fraudulent and unauthorized, thereby enabling McGrath to misappropriate the Debtors’ assets.
Newbridge has utilized Legent Clearing LLC as its clearing house since October 2007, formalized by a clearing agreement established around August 9, 2007, which mandates that all customer fund transfers be directed to Legent. Under this agreement, customers are responsible to Legent for payments related to securities transactions. Newbridge describes its relationship with McGrath as a standard customer-broker dealer interaction, noting that McGrath opened three brokerage accounts prior to the Petition Date, including one that was closed on July 10, 2009, which had minimal activity. Newbridge asserts that CU was never a customer or conducted any business with them.
On February 22, 2011, the Trustee initiated an adversary proceeding against Newbridge, subsequently filing an amended complaint with six counts. Count I seeks an accounting of funds Newbridge received from the Debtors. Count II, alleging intentional fraudulent transfer, claims that Newbridge received over $1 million in transfers with intent to hinder or defraud creditors within one year of the Petition Date. Count III, regarding constructive fraudulent transfer, contends that the Debtors received less than reasonably equivalent value for the transfers due to McGrath's fraud and that the Debtors were insolvent at the time of these transfers. The complaint indicates that the Debtors intended to incur debts beyond their ability to pay, with at least one pre-existing creditor at the time of each transfer.
Count IV alleges that the Trustee is entitled to actual damages under nonbankruptcy law for the misuse of Debtors’ funds by McGrath to purchase securities from Newbridge, invoking 11 U.S.C. 544, along with fees and costs. The Amended Complaint claims that McGrath fraudulently deprived the Debtors of funds, using them to acquire securities for his benefit or that of controlled entities, and that Newbridge colluded with McGrath in this fraudulent act, resulting in damages to the Debtors.
Count V, related to Aiding and Abetting Civil Conspiracy and Fraud, similarly asserts the Trustee’s right to judgment for actual damages, the amount misappropriated for securities, and associated fees and costs. It is alleged that Newbridge had actual knowledge of the fraudulent actions, provided significant assistance to McGrath’s scheme, and willfully ignored facts indicating its participation in the fraud, causing harm to the Debtors.
Count VI, on Conversion, claims the Trustee is entitled to recover the value of property converted by McGrath under 11 U.S.C. 550 and relevant nonbankruptcy law, along with fees and costs. The Trustee asserts that the Debtors had a rightful claim to the funds misappropriated by McGrath, which he fraudulently converted for personal benefit, with Newbridge also exerting control over the Debtors’ assets, leading to damages.
In a separate complaint filed against Vining Sparks, the Trustee alleges that prior to the Petition Date, Vining Sparks provided services to McGrath and related entities, receiving over $4.6 million in payments from the Debtors for securities purchases and commissions. The Trustee contends that Vining Sparks had fiduciary obligations to the Debtors, failed to provide equivalent value for the transfers, and knowingly assisted in the fraudulent misuse of the Debtors' assets, thus breaching its fiduciary duty. The Original Complaint against Vining Sparks includes six counts, with Count I seeking an accounting of all funds received from the Debtors.
Count II seeks judgment under 11 U.S.C. §§ 547 and 550 for the avoidance and recovery of $417,986.75 received by Vining Sparks within ninety days before the bankruptcy petition, including any additional amounts unknown to the Trustee. Count III, addressing Fraudulent Transfers, requests judgment under 11 U.S.C. §§ 544, 548(a)(1), and 550, as well as N.J.S.A. 25:2-25 et seq., alleging that transfers to Vining Sparks were made with the intent to hinder, delay, or defraud creditors, that the Debtors received less than reasonable equivalent value, that they were insolvent at the time or became insolvent as a result, and that they were engaged in transactions that left them with unreasonably small capital. Count IV alleges Civil Conspiracy, seeking judgment under non-bankruptcy law and 11 U.S.C. §§ 544 and 550, claiming Vining Sparks conspired with McGrath to fraudulently deprive the Debtors of property. Count V, Aiding and Abetting Civil Conspiracy and Fraud, seeks judgment under non-bankruptcy law and 11 U.S.C. §§ 544 and 550, alleging Vining Sparks ignored known facts of the fraud, causing injury to the Debtors. Finally, Count VI for Conversion seeks judgment under non-bankruptcy law and 11 U.S.C. §§ 544 and 550, asserting that Vining Sparks unlawfully received property converted by McGrath.
On August 24, 2011, Newbridge filed a Motion to Dismiss the Adversary Proceeding, claiming failure to state a claim under Fed. R. Civ. P. 12(b)(6) on eight grounds. Newbridge contends that Count I, Accounting, should be dismissed as the Trustee lacks legal grounds for an accounting, arguing that the Bankruptcy Code only allows such a demand if there is a custodian, which Newbridge is not. Additionally, Newbridge argues that Counts II and III must be dismissed because it is not a 'transferee' under 11 U.S.C. § 550(a).
Newbridge contends that the Trustee's claims are unsupported by factual evidence regarding the alleged Transfers made by the Debtors or received by Newbridge, failing to meet the Twombly and Iqbal pleading standards. Newbridge emphasizes that CU was never an account holder and that any account activity predates the alleged Transfers. It argues that it did not receive the Transfers or any related payments. Furthermore, Newbridge asserts it is neither an initial nor a subsequent transferee under Bankruptcy Code § 550(a), as it lacked dominion over the Transfers and was not a beneficiary under the Clearing Agreement. Newbridge also claims that the safe harbor provision in § 546(e) protects it from the Trustee's Constructive Fraudulent Transfer claim. Counts IV, V, and VI, concerning Civil Conspiracy and Fraud, should be dismissed based on the in pari delicto doctrine and lack of standing by the Trustee to assert creditors' claims. Additionally, Newbridge argues that civil conspiracy is not a standalone cause of action under New Jersey law and that the Trustee has not sufficiently stated any underlying tort. The entire Amended Complaint should be dismissed due to a lack of specificity in pleading, particularly in Counts II and V related to Intentional Fraudulent Transfer and Aiding and Abetting Fraud, which fail to meet the particularity requirement under Fed. R. Civ. P. 9(b). The Trustee filed a response opposing the motion to dismiss on November 11, 2011.
On October 28, 2008, Newbridge Securities received a $1,000,000 wire transfer from U.S. Mortgage, which the Trustee claims was used for purchasing securities, reimbursement for previous purchases, or commission payments. The Trustee seeks to recover this transfer, asserting sufficient legal grounds for each claim against Newbridge. Six main arguments are presented: (1) An accounting is justified due to the fiduciary duty owed to the Debtors and the complexity of the accounts. (2) Newbridge is a transferee liable for recovery under 11 U.S.C. § 550(a). (3) The safe harbor provision of 11 U.S.C. § 546(e) does not protect Newbridge, as the transfer is not a 'settlement payment.' (4) The in pari delicto defense is inappropriate at this stage due to the Defendant’s involvement in the Debtors’ fraud. (5) The Trustee has standing under the Debtors’ Third Amended Joint Plan of Liquidation. (6) Claims are adequately pleaded per Fed. R. Civ. P. 8(a) and 9(b). The Trustee requests denial of Newbridge's dismissal motion.
In response, Newbridge argues that the Trustee has failed to establish a claim for accounting due to lack of a fiduciary relationship and the availability of legal remedies. Newbridge contends that the fraudulent transfer claims are invalid under 11 U.S.C. § 550(a) since the transfer benefited Legent. It also asserts that the safe harbor provision under 11 U.S.C. § 546(e) protects the transaction and that claims involving civil conspiracy and conversion are not independently actionable or sufficiently pleaded. Vining Sparks similarly moves to dismiss, arguing no fiduciary duty exists and that the claims are barred by the safe harbor provision and the statute of limitations for transactions prior to 2008.
Vining Sparks contends that Counts III-VI of the Complaint do not meet the fraud pleading requirements under Fed. R. Civ. P. 9(b) and that the entire Complaint fails to comply with the standards of Fed. R. Civ. P. 8(a). It asserts that as a broker-dealer regulated by the Securities Exchange Act of 1934, the transfers in question are protected under the safe harbor provision of 11 U.S.C. 546(e). Vining Sparks argues that the Complaint acknowledges the transactions were securities-related, involving payments for securities purchases, reimbursements for prior purchases, or commission payments. It further claims that the Trustee's allegations lack specific factual support for actual fraud and are merely repetitive of statutory language. Vining Sparks criticizes the Trustee for bringing claims against multiple securities firms without adequate factual basis, arguing this approach contradicts the intent of Congress in enacting the safe harbor.
Additionally, Vining Sparks asserts that Counts I (Accounting), IV (Civil Conspiracy), V (Aiding and Abetting Civil Conspiracy and Fraud), and VI (Conversion) are based on state law and thus barred by 11 U.S.C. 546(e), which protects transactions related to securities settlements. It emphasizes that reversing these transactions could harm financial market stability. Vining Sparks maintains that the safe harbor provisions exclude the maintenance of 544 claims, with the only exception being claims under 548(a)(1)(A), which it argues are also inapplicable because the Debtors received value that prevents avoidance under that section. The firm highlights several deficiencies in the Trustee's pleading, including failure to plead fraud with particularity, vagueness regarding the timeliness of claims, the civil conspiracy claim lacking an intentional tort basis under New Jersey law, and the absence of a valid conversion claim as no unlawful dominion over the property was asserted.
In response, the Trustee filed an Opposition to the Motion to Dismiss, requesting the Court to consider facts from the Amended Complaint, and noted that Vining Sparks’ account representative had a social relationship with McGrath.
The Trustee claims McGrath used high doses of Xanax obtained illegally online, which was known to Vining Sparks due to discussions between McGrath and Thompson. The Trustee argues that Count I (Accounting) is justified as Vining Sparks had a fiduciary duty to the Debtors, the case complexities necessitate discovery, and the safe harbor provision of 11 U.S.C. § 546(e) does not apply to Counts II-VI since the transfers were not "settlement payments" or ordinary transactions. The Trustee maintains that the claims are timely, falling within applicable statutes of limitation, and are adequately pled under Federal Rules 8(a) and 9(b). He asserts that the Debtors engaged in massive fraud, making the payments non-standard in the securities trade context. The Trustee contends that § 546(e) does not preclude claims under 11 U.S.C. § 544 and that it limits avoidance powers under § 548(a)(1)(B), but not under § 548(a)(1)(A). He argues that, regardless of how "settlement payments" are defined, the transfers stem from fraud and should not be protected by § 546(e). The Trustee emphasizes that preventing avoidance of these transfers contradicts the goals of § 546(e). He asserts valid claims for fraud, Civil Conspiracy, Aiding and Abetting Civil Conspiracy and Fraud, and Conversion, and requests permission to amend the Complaint if it is dismissed. The Liquidating Trustee has filed a cross-motion to amend the complaint in the Bond v. Vining Sparks case.
The Trustee contends that Rule 15(a)(2) permits amendments to pleadings only with the opposing party’s written consent or the court’s permission, which should be granted liberally when justice requires it. The Trustee seeks to file an Amended Complaint to address issues raised in a Motion to Dismiss, incorporating additional factual allegations, clarifying causes of action, and correctly naming the Defendant as Vining Sparks IBG, L.P. The proposed Amended Complaint differentiates Count III (Fraudulent Transfer) into two counts: Count III (Intentional Fraudulent Transfers) and Count IV (Constructive Fraudulent Transfers), citing transfers made within four years prior to the U.S. Mortgage Petition Date totaling at least $4,602,464.00. The Amended Complaint also reclassifies Counts V (Civil Conspiracy), VI (Aiding and Abetting Civil Conspiracy and Fraud), and VII (Conversion) as damage claims.
On August 11, 2011, Vining Sparks opposed the Trustee's cross-motion and Amended Complaint, reiterating arguments from its Memorandum of Law in support of its Motion to Dismiss. These arguments include: (1) the safe harbor of 11 U.S.C. § 546(e) precludes the Trustee’s claims, (2) failure to plead fraud with particularity, (3) lack of a fiduciary duty owed by Vining Sparks to the Debtors, rendering the request for an accounting unnecessary, (4) failure to state a claim under Federal Rules of Bankruptcy Procedure, (5) state law claims being barred by New Jersey law, and (6) claims being outside the statute of limitations because the relevant transactions occurred between 2005 and 2008. Vining Sparks additionally asserts that Counts I, V, VI, and VII are barred by the in pari delicto doctrine and claims that the Amended Complaint does not resolve the defects previously identified. Vining Sparks requests that the Trustee's cross-motion be held in abeyance or denied based on its Motion to Dismiss.
During a hearing on December 1, 2011, it was noted that Newbridge is recognized as a stockbroker under the Code, and while mortgage fraud by McGrath was acknowledged, there were no allegations of illegal trading by Newbridge. Consequently, all claims, except for the one under 548(a)(1)(A), are deemed barred by the safe harbor provision.
Transactions are classified as payments under a securities contract and qualify as settlement payments, thus falling under the protections of § 546(e). Counsel for Newbridge contended that maintaining state law actions would circumvent these protections. They argued for the dismissal of the § 548(a)(1)(A) claim (Count II) on three grounds: 1) Newbridge is not a "transferee" since all transfers were processed through its clearinghouse, Legent, with Newbridge only receiving commissions. 2) As a stockbroker, Newbridge lacked dominion over the funds and merely acted as a custodian. 3) The Trustee failed to demonstrate intent to hinder, delay, or defraud creditors, noting that McGrath's actions, while fraudulent, did not exhibit fraudulent intent as per the complaint's claims about using funds to enhance investments.
For Count I, Newbridge’s counsel argued that there were legal remedies available and no fiduciary duty existed due to the absence of a discretionary trading account, as required customer forms were not signed. The claim for Conversion should fail due to the lack of identifiable funds, and the Civil Conspiracy to Commit Fraud count lacks a legal basis. Newbridge invoked the in pari delicto defense.
Counsel for Vining Sparks supported Newbridge’s arguments, asserting that under § 548(d), the payments were for value and that no allegations of participation in mortgage fraud existed against them. Vining Sparks claimed that § 546(e) provides a complete bar to actions, except for intentional fraud, which was not alleged against them. They contended that the safe harbor provision also applies to the § 548(a)(1)(A) claim, supported by the “good faith transferee” exception and the in pari delicto defense.
Conversely, the Trustee argued that McGrath's significant fraud removes the transactions from the safe harbor of § 546(e), asserting that the special relationship between McGrath and certain broker employees should exempt the case from the standard broker-client relationship.
Counsel for the Trustee contended that the safe harbor provision does not preempt state law claims because they seek different remedies, specifically damages to be determined at trial. The Trustee argued for the necessity of conducting discovery to establish whether a fiduciary relationship existed, asserting that Newbridge Securities and Vining Sparks downplayed the relationship between McGrath and their brokers. The Trustee maintained that the transfer in question, while not directly involving Newbridge, benefited Newbridge, including commission payments, and thus the Motion to Dismiss should be denied. The Trustee claimed that the complaint satisfies Rule 9's specificity requirements regarding both Newbridge and Vining Sparks and emphasized that Newbridge had discretionary authority over the accounts, justifying further discovery.
Regarding the Conspiracy count, the Trustee argued that the underlying fraud was adequately pled as per Rule 9(b). Vining Sparks claimed that any transfers beyond the two-year reach-back period under Bankruptcy Code Sections 548 and 546(a) are barred, while the Trustee relies on a four-year reach-back period under New Jersey state law for fraudulent conveyances. Newbridge also requested that, if suitable, the Court convert its motion to one for summary judgment.
On March 28, 2013, a conference call was held with the parties, leading to a request for supplemental submissions. Vining Sparks submitted a letter on April 5, 2013, stating no significant legal changes had occurred since the initial hearing and asserting that the safe harbor provision protects it from state law claims under Section 544 and also applies to preference actions under Section 547. Vining Sparks confirmed its status as a "stockbroker" under the Bankruptcy Code.
In response, the Trustee's April 12, 2013 letter argued that Section 546(e) does not shield the defendants from state law claims under Section 544. The Trustee pointed out that the intentional fraud claims under Section 548(a)(1)(A) stem from McGrath's actions, which also give rise to state law claims. The Trustee cited Lehman Bros. Holdings, Inc. to assert that safe harbors do not provide an absolute defense against claims from market participants whose actions may lead to liability, arguing that McGrath's fraudulent intent disqualified the transfers from safe harbor protections.
The Trustee maintains that state law claims should not be dismissed, acknowledging Vining Sparks as a broker-dealer similar to Newbridge but asserting a distinct relationship due to Bill Thomson's personal connection with Michael McGrath, including knowledge of McGrath's drug use. The Trustee indicated no changes in relevant facts or law that would affect the pending motions. In response, Vining Sparks contended that the Trustee's citation of the Lehman case has been distinguished in AP Services LLP v. Silva, which ruled that state law claims are preempted by 11 U.S.C. § 546(e) when they seek recovery of payments deemed unavoidable under that section. Additional case law cited by Vining Sparks supports this position, indicating that allowing recovery on state law claims could undermine the purpose of § 546(e). Vining Sparks argued that the Trustee's state law claims parallel claims made in the proposed Amended Complaint, which seek to recover the same transfers. They claimed that permitting the Trustee to pursue these state law claims would frustrate the intent of § 546(e). Furthermore, Vining Sparks reiterated that the Trustee's assertions regarding the relationship between Thomson and McGrath do not fulfill the pleading standards of Federal Rules of Civil Procedure 12(b)(6) and 9, lacking sufficient factual content to infer that Vining Sparks is not a stockbroker. The legal standards for a motion to dismiss under Federal Rule of Civil Procedure 8(a) require that any claim for relief must be adequately stated.
A complaint must contain: (1) a concise statement of the court's jurisdiction; (2) a clear statement of the claim demonstrating entitlement to relief; and (3) a demand for the sought relief, which may include alternative forms of relief, as per Federal Rule of Civil Procedure 8(a) and Federal Rule of Bankruptcy Procedure 7008. A motion to dismiss for failure to state a claim can be filed under Federal Rule of Civil Procedure 12(b)(6), applicable in bankruptcy through Federal Rule of Bankruptcy Procedure 7012. In evaluating such a motion, the court accepts all well-pleaded allegations as true and views them favorably towards the plaintiff, assessing whether the complaint allows for a reasonable inference of liability. A claim achieves facial plausibility when its factual content supports an inference of the defendant's misconduct. The Supreme Court's two-step analysis for dismissals involves discarding conclusory allegations and employing judicial experience to gauge the plausibility of the claim. There is no requirement for a probability at the pleading stage; rather, the facts must raise a reasonable expectation for discovery to yield necessary evidence. Courts typically consider the complaint's allegations, attached exhibits, public records, and documents underlying the claim when deciding motions to dismiss. Section 546(e) of the Bankruptcy Code offers a "safe harbor" by protecting specific transfers from avoidance actions, particularly shielding certain settlement payments to maintain stability in financial markets, as established in relevant case law.
Section 546(e) of the Bankruptcy Code prohibits trustees from avoiding certain transfers related to margin and settlement payments made by or to specified financial entities, including commodity brokers and securities clearing agencies, prior to the commencement of bankruptcy proceedings. This provision aims to stabilize the commodities and securities markets during significant bankruptcies, preventing the ripple effect of one firm's insolvency on others. The term "settlement payment," as defined in Section 741, includes various types of payments commonly used in securities transactions, and has been interpreted broadly by the Third Circuit. In Bevill, Bresler, Schulman Asset Management Corp. v. Spencer Savings & Loan Association, the court established that settlement payments encompass cash deposits or securities transfers integral to completing a transaction, regardless of when they occur in the settlement process. Similar interpretations were reinforced in subsequent cases, such as In re Resorts International, Inc., where the court reiterated that a settlement payment generally involves the transfer of cash or securities to finalize a securities transaction.
The term "settlement payment" encompasses nearly all securities transactions, as established by the court. It aligns with the definition from *Enron Corp. v. Int’l Fin. Corp.*, where any cash or security transfer to complete a securities transaction qualifies as a settlement payment. This definition includes early redemption payments of commercial paper, which are protected by the safe harbor provision of § 546(e) of the Bankruptcy Code, without necessitating a purchase or sale requirement.
However, the safe harbor provision may be disregarded in cases of systemic fraud, which can affect a transaction's classification as a "settlement payment." Instances of fraud, such as phantom securities transactions or illegal transfers, have led courts to deny the application of § 546(e). For example, in *In re Grafton Partners*, the court rejected the safe harbor for an illegally unregistered security. Similar rulings occurred in *Jackson v. Mishkin* and *Wider v. Wootton*, where transactions were deemed too fraudulent to be considered typical in the securities trade.
Additionally, § 546(e) applies to transfers associated with stockbrokers or securities clearing agents in relation to a "securities contract," as defined in § 741(7) of the Bankruptcy Code. A "stockbroker" is defined under § 101(53A) as an entity engaged in securities transactions for customers or the general public. Meanwhile, a "securities contract" includes various agreements related to securities, loans, or repurchase transactions.
Options related to foreign currencies traded on national securities exchanges are included, along with guarantees by or to securities clearing agencies for settlements involving cash, securities, and related financial instruments. Margin loans and extensions of credit for securities transactions are also covered, as are various loan transactions linked to securities, including securities collars, prepaid forward securities, and total return swaps. The provisions extend to similar agreements or combinations of transactions within this framework and any options to enter such agreements.
A master agreement encompassing these transactions, including any supplements, is considered a securities contract only for those agreements specifically outlined in prior clauses. Additionally, security agreements or credit enhancements related to these transactions, including guarantees by financial entities, are included but limited to damages as per section 562. However, it excludes obligations under commercial mortgage loan participation.
The Supremacy Clause of the U.S. Constitution establishes that state laws conflicting with federal laws are preempted. Preemption can occur explicitly or implicitly, with two primary forms: conflict preemption, where compliance with both laws is impossible, and field preemption, where federal regulation is so comprehensive that it implies the absence of state regulation.
In the case of Hechinger, an unsecured creditors' committee initiated an adversary proceeding against former directors, controlling shareholders, and lenders involved in a leveraged buyout (LBO) of the corporate debtor, raising claims for fraudulent conveyance, breach of fiduciary duty, unjust enrichment, and equitable subordination. The court first dismissed the fraudulent conveyance claim under the safe harbor provision of § 546(e) of the Bankruptcy Code. Regarding the breach of fiduciary duty claim, the court dismissed it for some defendants while allowing it for others. The court then addressed the unjust enrichment claim, ruling it was preempted by § 546(e). The court explained that the unjust enrichment claim sought the same remedy as the fraudulent conveyance claim—recovering payments made to shareholders during the Hechinger LBO—which would circumvent the protections of § 546(e). The court noted that claims deemed unavoidable under the Bankruptcy Code cannot be recharacterized as unjust enrichment claims to evade these provisions. It concluded that allowing such recovery would undermine the intent of Congress and the purpose of § 546(e), which prevents the unraveling of settled securities transactions after one year. Additionally, the court found that the Bankruptcy Code provides an exclusive framework for addressing claims related to transfers made more than one year before bankruptcy, thus preempting state law remedies.
The Bankruptcy Code permits debtors to avoid certain payments under section 544, which allows avoidance of payments that could be contested under state law outside of bankruptcy. However, this power is limited by federal provisions, specifically 11 U.S.C. § 546(e), which protects settlement payments from being avoided in bankruptcy. Congress intended for these federal provisions to displace conflicting state law claims and remedies. Consequently, any common law claims that merely re-label avoidance actions are preempted by the Bankruptcy Code to preserve the integrity of § 546(e).
In the case of In re Lehman Brothers Holdings Inc., the court examined the boundaries of § 546(e) and the preemption of state law claims, ruling that while the "safe harbor" provision does not provide absolute immunity, it does not encompass every possible claim related to transactions fitting within its statutory framework. The court emphasized that the protections offered by the safe harbors do not shield defendants from all claims linked to their conduct.
Defendants in the Lehman case contended that federal bankruptcy law preempted certain unjust enrichment and conversion claims, citing prior cases for support. However, the Lehman court differentiated those cases, noting that the unjust enrichment claims presented were not equivalent to claims for constructively fraudulent transfers. Instead, they were rooted in actual fraudulent intent and did not seek the same relief as claims protected under § 546(e).
State law claims that are based on facts distinct from those required for constructively fraudulent transfers under sections 544 or 548, which are protected by the safe harbor provision in section 546(e), should not be dismissed. In AP Services LLP v. Silva, the court determined that a trustee's claim for unjust enrichment was preempted by section 546(e) because it sought to recover the same payments deemed unavoidable under that section. Conversely, claims for breach of fiduciary duty and aiding and abetting such breaches were not preempted, as they involve monetary damages that do not threaten the stability of settled securities transactions, which section 546(e) aims to protect.
The court also highlighted that section 546(e) bars a trustee from pursuing claims under 11 U.S.C. 548(a)(1)(B) and 544, as seen in cases like Securities Investor Protection Corp. v. Madoff and Picard v. Katz, where claims related to preference payments and fraudulent conveyances were dismissed. Section 548(a)(1)(A) pertains to intentional fraudulent transfers, allowing avoidance of transfers made with intent to defraud. However, section 548(c) allows a good faith transferee who receives value to retain the interest transferred, provided the transfer is not voidable under sections 544, 545, or 547. Additionally, section 548(d)(2)(B) clarifies that certain financial entities receiving margin or settlement payments take for value to the extent of those payments.
Section 741 of the Bankruptcy Code defines "settlement payment" to include various types of payments common in securities transactions, such as preliminary, partial, interim, and final settlement payments. The Third Circuit interprets this term broadly, recognizing that in the securities industry, a settlement payment generally refers to the transfer of cash or securities that finalizes a transaction.
Section 548(a)(1)(A) allows a trustee to avoid transfers made within two years prior to the bankruptcy petition if such transfers were made with the intent to hinder, delay, or defraud creditors. This section does not fall under the safe harbor provision of Section 546(e). Section 546(a) establishes the time limits for initiating actions related to certain sections of the Bankruptcy Code, specifying that actions must commence within two years of the order for relief or one year following the election of the first trustee, or before the case is closed or dismissed.
Under New Jersey law (N.J.S.A. 25:2-31), actions regarding fraudulent transfers must be brought within specified timeframes: four years from the transfer or obligation date, or within one year of discovering the transfer or obligation for certain claims.
An accounting is recognized as an equitable remedy that requires demonstrating the lack of an adequate legal remedy. For equitable remedies, such as accounting, the absence of an adequate legal remedy is a necessary prerequisite, as established in case law.
A court will address a claim for accounting after determining that there is no adequate legal remedy. Under New Jersey law, an equitable accounting is not a right but is granted based on three criteria: 1) the existence of a fiduciary or trust relationship, 2) the complexity of the account, and 3) the necessity for discovery. A fiduciary relationship between a broker and client arises when the broker possesses discretionary trading authority. Conversely, no fiduciary relationship exists if the client maintains a non-discretionary account. Section 550(a) of the Bankruptcy Code governs the liability of transferees of avoided transfers. It allows a trustee to recover either the property or its value from the initial transferee or any immediate or mediate transferee. The term "initial transferee" is undefined in the Bankruptcy Code, but courts have interpreted "transferee" to mean someone who actually receives funds and has full dominion and control over them for personal use, not merely as an agent or trustee. Courts require that a transferee has the legal right to use the funds for any purpose.
A subsequent transferee cannot be considered the "entity for whose benefit" an initial transfer was made, as established in Bonded Financial Services, Inc. v. European American Bank. The court clarified that the statute distinguishes between initial transferees and beneficiaries, highlighting that the beneficiary is different from any immediate or mediate transferee. A typical beneficiary is a guarantor or debtor who gains a benefit from the transfer without directly receiving funds. The court further asserted that those who later receive the money are not classified as beneficiaries. This interpretation was upheld by the United States District Court for the District of New Jersey in YA Global Inv. L.P. v. Global Outreach, S.A., reinforcing that the categories in subsections 550(a)(1) and 550(a)(2) are mutually exclusive.
Regarding amended pleadings, Fed. R. Civ. P. 15(a)(2) allows a party to amend a pleading once before a responsive pleading is served, and subsequently only with court permission or the opposing party's consent. Amendments should be granted freely unless there is evidence of undue delay, bad faith, or other specified reasons for denial. The Supreme Court in Foman v. Davis outlined that the refusal to grant leave to amend without valid justification constitutes an abuse of discretion, contrary to the Federal Rules' spirit. Grounds for denying amendments include undue delay, bad faith, dilatory motives, prejudice to the opposing party, and futility of the amendment.
The Third Circuit mandates that a claim vulnerable to dismissal under Rule 12(b)(6) should generally be allowed to amend unless the amendment fails to address the deficiency. In the case of Newbridge Securities’ Motion to Dismiss, the court found that the safe harbor provision of 11 U.S.C. § 546(e) necessitates the dismissal of state law claims aimed at avoiding intentional fraudulent transfers under the Trustee’s strong-arm powers. Specifically, Counts II, IV, V, and VI—pertaining to constructive fraudulent transfers, civil conspiracy, aiding and abetting civil conspiracy and fraud, and conversion—are dismissed because the Transfers in question qualify as "settlement payments" under both the Bankruptcy Code and established Third Circuit precedent.
The court interpreted the term "settlement payment" broadly, encompassing transfers made to complete securities transactions, as detailed in In re Resorts Int’l, Inc. The Trustee acknowledged that the Transfers at issue were linked to securities transactions, thus reaffirming their classification as settlement payments. Additionally, the court held that the preemption doctrine bars state common law claims from circumventing the provisions of § 546(e). The Trustee's arguments citing various cases to dispute this classification were found unpersuasive, leading to the conclusion that the safe harbor provision applies to the claims raised.
Section 546(e) addresses the treatment of transfers in cases involving phantom or fictitious securities transactions that are illegal or not typically part of the settlement process. It emphasizes that systemic fraud can affect whether a transaction qualifies as a "settlement payment." When systemic fraud exists, it violates the definition of "settlement payment" in 11 U.S.C. § 741(8), which includes "any other similar payment commonly used in the securities trade." However, the current matter is distinct from prior cases cited by the Trustee. While McGrath was involved in significant fraud, the alleged transfers were legitimate purchases of securities from a market participant, retaining their status as "settlement payments" despite the fraudulent allegations against the Debtors.
Additionally, Section 546(e) applies to transfers made by, to, or for the benefit of a stockbroker in relation to a "securities contract," per 11 U.S.C. § 741(7). The Complaint indicates that the transfers to Newbridge Securities were for purchasing securities, reimbursing purchases, or paying commissions, which the Trustee acknowledges. This confirms that the transfers were tied to securities transactions, thus further justifying the application of the safe harbor provision of § 546(e).
Furthermore, the Amended Complaint includes state law claims for civil conspiracy and aiding and abetting conspiracy and fraud under § 544 and relevant non-bankruptcy law. For Count VI (Conversion), the Trustee claims recovery of property under applicable non-bankruptcy law and § 550. However, the original complaint for conversion cites recovery under § 544 instead of § 550. The Court determines that the language of § 546(e) bars the Trustee's common law claims under § 544.
Newbridge Securities contends that the Trustee's claims in Counts IV (Civil Conspiracy), V (Aiding and Abetting Civil Conspiracy and Fraud), and VI (Conversion) conflict with Congressional objectives as outlined in § 546(e) of the Bankruptcy Code. The Court agrees, ruling that these counts are preempted and must be dismissed under the safe harbor provision of § 546(e). The claims are deemed to circumvent the protections afforded by this provision, as they seek essentially the same relief through different labels.
Count VI, despite being framed under non-bankruptcy law, is also dismissed because it effectively serves as an avoidance claim, similar to those in Counts IV and V. The Court highlights that all three counts are based on the same facts and seek the recovery of transfers, which falls within the scope of § 546(e).
The preemption doctrine negates the need to address Newbridge Securities' arguments regarding the in pari delicto doctrine for claims under the safe harbor provision. Additionally, while the Trustee claims standing to pursue these causes of action, the Court clarifies that the Plan preserves rather than creates such causes.
In the Amended Complaint, the Trustee asserts that on October 28, 2008, Newbridge Securities received payments exceeding $1,000,000 from the Debtors. Counts II (Intentional Fraudulent Transfers) and III (Constructive Fraudulent Transfers) seek recovery of these transfers under § 550(a) of the Bankruptcy Code. The Trustee identifies Newbridge Securities as an "initial transferee" under § 550(a)(1), and the Court references a prior ruling regarding the definition of "initial transferee" for these purposes.
To qualify as a "transferee" of the debtor's funds, an entity must (1) actually receive the funds and (2) possess full dominion and control over them for its own account, not merely as a trustee or agent. The court is currently unable to determine the extent of Newbridge Securities' dominion and control over the Transfers. Newbridge Securities claims it was not an initial transferee based on the Clearing Agreement with Legent and argues that the Transfers were not for its benefit. Conversely, the Trustee cites a $1,000,000 wire transfer from U.S. Mortgage to Newbridge Securities as evidence that it was an initial transferee. Newbridge Securities contends that the funds were actually wired to Legent’s account. The court concludes that the current record does not provide sufficient legal clarity to determine if Newbridge Securities qualifies as an initial transferee, which is essential for the Trustee to recover the Transfers' value. Consequently, Count III (Constructive Fraudulent Transfer) is dismissed under the safe harbor provision, while the motion to dismiss Count II (Intentional Fraudulent Transfers) is denied.
Regarding the heightened pleading standard for fraud claims under Federal Rule of Civil Procedure 9(b), the court finds that the Trustee has adequately met this requirement for Count II. As for Count I (Claim for Accounting), the court cannot yet rule on the existence of a fiduciary relationship between Newbridge Securities and the Debtors, as the Trustee claims such a relationship existed due to discretionary trading authority being delegated. The court agrees that further discovery is needed to explore this potential relationship and, thus, denies the motion to dismiss Count I. The Trustee is granted leave to file a second amended complaint regarding the $1,000,000 transfer within 30 days.
The Court determines that the safe harbor provision under 11 U.S.C. § 546(e) requires the dismissal of several claims in both the Original Complaint and Proposed Amended Complaint. Specifically, claims in Count II (Preference) and Count III (Fraudulent Transfers) based on 11 U.S.C. § 548(a)(1)(B) and 11 U.S.C. § 544, as well as claims in Count IV (Civil Conspiracy), Count V (Aiding and Abetting Civil Conspiracy and Fraud), and Count VI (Conversion), are dismissed because the transfers in question qualify as "settlement payments" as per the Bankruptcy Code and established Third Circuit case law.
The Court highlights that § 546(e) applies to transfers made by or for the benefit of stockbrokers and related entities during securities transactions, reinforcing that the transfers meet the definition of settlement payments. Citing Third Circuit precedent, it clarifies that settlement payments encompass various types of cash or securities transfers that finalize securities transactions. The Trustee's acknowledgment in the Complaint that the transfers were for purchasing securities or paying commissions supports this classification.
Additionally, the Court rejects the Trustee's argument to apply precedents from other cases that exclude certain transactions from being considered settlement payments, emphasizing that systemic fraud does not alter the nature of the transactions in this case. Thus, the claims are barred by the safe harbor provision, emphasizing the legal protection afforded to settlement payments in the context of securities transactions.
The term “settlement payment” as defined in 11 U.S.C. § 741(8) includes “any other similar payment commonly used in the securities trade.” The current case is distinct from those cited by the Trustee, despite allegations of fraud by Defendant's employees. The alleged Transfers represent legitimate purchases of securities, maintaining their classification as “settlement payments” regardless of the fraud claims. Additionally, the Transfers qualify for the safe harbor under 11 U.S.C. § 546(e) because they were made in connection with a “securities contract,” as defined in 11 U.S.C. § 741(7). Vining Sparks, a registered securities broker-dealer, provided services to McGrath and related entities, with payments made to Vining Sparks for purchasing securities or covering commissions, further supporting the applicability of the safe harbor provision.
Furthermore, the Court determines that § 546(e) requires the dismissal of state common law claims, specifically those in Counts IV (Civil Conspiracy), V (Aiding and Abetting Civil Conspiracy and Fraud), and VI (Conversion). Both the Original and Proposed Amended Complaints assert that these claims are avoidable under § 544 and applicable non-bankruptcy law. The language of § 546(e) bars these claims, necessitating their dismissal. The Proposed Amended Complaint's Count VII (Conversion) seeks recovery under § 550 and applicable non-bankruptcy law, but merely re-labeling claims to circumvent § 546(e) undermines its intent, as supported by case law.
In the Proposed Amended Complaint, the Trustee seeks recovery under Count VII based on non-bankruptcy law and § 550 instead of § 544. However, the Court determines that Count VII still falls under the jurisdiction of § 546(e). Similar to the Hechinger case, the Trustee's state law claims are effectively avoidance claims. Permitting these claims would allow the Trustee to bypass the safe harbor provision of § 546(e). Counts V (Civil Conspiracy), VI (Aiding and Abetting Civil Conspiracy and Fraud), and VII (Conversion) share the same underlying facts and seek similar relief—specifically, the avoidance and recovery of the transfers or the funds used for those transfers. Therefore, the Court concludes that Counts V-VII must be dismissed under the safe harbor provision of § 546(e).
The preemption doctrine applies, negating the need to address Vining Sparks’ arguments regarding the in pari delicto doctrine for claims under § 546(e). The Court also refrains from applying in pari delicto to any remaining claims at the motion to dismiss stage due to the doctrine's fact-intensive nature. The Court rules that the Plan does not create new causes of action for the Trustee but merely preserves those of the Debtor.
Count II, regarding the avoidance and recovery of Preferential Transfers under § 547(b) and § 550, is dismissed as § 546(e) bars such claims. For the § 548(a)(1)(A) Intentional Fraud claim (Count III), Vining Sparks has not established a legal basis for dismissal, and the Court finds it premature to decide on the good faith transferee provision at this stage. Claims for any § 548(a)(1)(A) transfers made before the two-year reach back period (before February 23, 2007, given the U.S. Mortgage Petition Date of February 23, 2009) are deemed untimely and must be dismissed. Lastly, the Court is undecided on the existence of a fiduciary relationship concerning the accounting claim (Count I).
The Trustee argues that a fiduciary relationship existed between the Debtors and Vining Sparks due to the Debtors delegating discretionary trading authority to Vining Sparks. The Court agrees that discovery is necessary to explore this relationship, thereby denying the Motion to Dismiss regarding the Claim for Accounting (Count I). The Court references relevant case law, emphasizing that a finding of a fiduciary relationship is essential for the claim's viability.
Regarding the Trustee’s Cross-Motion to amend the complaint, a liberal standard for amendments is applied, as established by Foman v. Davis and Fed. R. Civ. P. 15(a)(2), which advocates for granting leave to amend unless specific reasons such as futility or undue prejudice are present. The Court evaluates whether allowing the amendment would be futile based on its previous rulings on Vining Sparks' Motion to Dismiss.
The original complaint's Counts II (Avoidance and Recovery of Preferential Transfers), III (Constructive Fraudulent Transfers), and various state law claims are dismissed under the safe harbor provision of 546(e). The remaining claims include Count I (Accounting) and Count III (Intentional Fraudulent Transfers). The proposed amended complaint similarly dismisses several counts under the same provision, retaining Count I (Accounting) and Count III (Intentional Fraudulent Transfers).
The proposed amendment primarily alters factual details and separates the Fraudulent Transfer claim into Intentional and Constructive categories. The Court decides to grant the Trustee's motion to amend consistent with its opinion but notes that Federal Rule of Civil Procedure 9(b) requires specific details in allegations of fraud, mandating particularity in the fraud claims.
Plaintiffs can fulfill the pleading requirement for fraud by specifying the 'date, place, or time' of the alleged fraud or by providing alternative methods to add precision to their claims, as established in Lum v. Bank of America and Seville Indus. Mach. Corp. v. Southmost Mach. Corp. The Trustee must adhere to the heightened pleading standard of Rule 9(b) for the Intentional Fraudulent Transfers claim (Count III) by detailing the specific transfers involved, including their dates. The court partially granted and partially denied motions to dismiss from Newbridge Securities and Vining Sparks. The Liquidating Trustee's motion to file an amended complaint in the case Bond v. Vining Sparks was granted, requiring the amended complaint to be filed within thirty days. Additionally, there was a citation error regarding the statutory basis for both the state law claim and the state law conversion claim, referencing § 550 instead of § 544. The CU National Petition Date is noted as April 1, 2009, establishing a two-year look-back period for relevant transfers, ending on April 1, 2007.
