REBECCA R. PALLMEYER, United States District Judge The short-term cash management firm Sentinel Management Group, Inc. collapsed and filed for bankruptcy in August 2007 at the outset of the financial crisis. Required by federal law to segregate its clients funds and invest in only the highest grade government securities, Sentinel instead pledged the securities in its clients accounts as collateral for loans from the Bank of New York-which Sentinel then used to buy even more securities on its own House account for the benefit of corporate insiders. As credit markets tightened in the summer of 2007, Sentinel found itself unable to both repay the Banks loan and return its clients money on demand. All told, Sentinel cost its investors more than $600 million. See United States v. Bloom , 846 F.3d 243, 245-46 (7th Cir. 2017) (affirming Sentinel CEO Eric Blooms convictions on nineteen counts of wire fraud and investment advisor fraud). Dozens of lawsuits were filed in the wake of Sentinels failure. Many are ongoing to this day.
Defendant UBS Securities, LLC is a former customer of Sentinel. In March 2007, Sentinel transferred $108 million to UBS, which included $14.4 million characterized as cumulative interest. (UBS Securities, LLCs Memorandum in Support of its Motion for Summary Judgment [97] (UBSs Opening Br.), 1.) The Plaintiff in this case, Frederick J. Grede, is the Liquidation Trustee for the Sentinel Liquidation Trust. The Trustee claims that Sentinel acted with actual intent to hinder, delay, and defraud its other creditors when making the pre-petition transfer to UBS, and argues that the cumulative interest payment represents false profits. (Complaint [1] in No. 09-BR-521, 18-19) (citing 11 U.S.C. § 548(a)(1)(A) ). Accordingly, the Trustee seeks to avoid the transfer and return the $14.4 million to the Liquidation Trust. UBS has moved for summary judgment, arguing that the Trustee has alleged only a general scheme to defraud, and not fraudulent intent with respect to the specific transfer at issue. (UBSs Opening Br. 2.) UBS asserts that the cumulative interest was neither false nor profits, but rather the proceeds of Sentinels legitimate investment activity-which Sentinel properly paid to UBS in fulfillment of its legal and contractual obligations. (Id. )
For the reasons stated below, the Defendants motion for summary judgment [96] is granted.
FACTUAL BACKGROUND
1. Overview of Sentinels Business and Bankruptcy
Sentinel Management Group, Inc. was an Illinois corporation that provided cash-management services for institutional investors, hedge funds, and individuals. (UBS Securities LLCs Local Rule 56.1 Statement of Uncontested Material Facts [98] (UBS SoF), ¶ 3.) Its primary business consisted of making safe, short-term investments of the excess cash held by other investment firms called futures commission merchants (FCMs)-brokers that execute trades in the futures and options markets and that are regulated by the Commodity Futures Trading Commission (CFTC). (Id. ) Although Sentinel did not itself execute futures or options trades, it too was registered as an FCM with the CFTC as a prerequisite for managing the funds of typical FCMs. (Id. ); see also Bloom , 846 F.3d at 246 (describing Sentinels business model as unique and operating like a mutual fund, pa[ying] a return based on profits and losses.) Importantly, this meant that Sentinel was governed by the same securities law and regulations as its clients. (UBSs SoF ¶ 4.) These regulations required Sentinel to maintain its clients funds in segregated accounts, and limited Sentinels use of those funds to investments [in] certain high-quality government and corporate securities such as U.S. Treasury bills. (Id. at ¶¶ 9-10) (citing 7 U.S.C. § 6d(b) and 17 C.F.R. § 1.25 ).
Sentinel offered a variety of investment programs to account for different investment objectives and to comply with various regulations, but ultimately pooled all of its clients assets into one of three distinct groups. (UBSs SoF ¶ 10) Sentinel called these groups SEG 1, SEG 2, and SEG 3. (Id. ) When advertising its investment options to potential customers, Sentinel referred to the SEG 1 group as the 125 Portfolio (named after CFTC Rule 1.25) and the SEG 3 group as the Prime Portfolio. Bloom , 846 F.3d at 247. SEG 1 was more conservative and intended for FCMs investing their own customers funds, while SEG 3 offered a higher rate of return at slightly greater risk and was open to Sentinels non-FCM clients: hedge funds, individuals, and FCMs investing their proprietary, non-customer funds. Id. Clients who invested money into one or more SEGs were promised an undivided, pro-rata beneficial interest in the pool of securities purchased using the funds within each SEG. (UBSs SoF ¶ 12.) This meant that Sentinels investors did not own specific securities outright, but saw their funds exchanged for securities and interest-bearing cash through a process that Sentinel called allocation and instead held indirect shares of their respective SEG based on their level of investment. Grede v. FCStone, LLC , 867 F.3d 767, 771 (7th Cir. 2017) ( FCStone II ).
In addition to making trades for its clients, Sentinel also traded on its own House account for the benefit of corporate insiders, which included the chairman, Philip Bloom; the CEO, Eric Bloom (Philips son); and the vice president of trading, Charles Mosley. (Trustees Statement of Additional Material Facts in Opposition to UBSs SoF [112] (Trustees SoAF), ¶ 4.) Sentinels House account was not constrained by the laws and regulations that governed the grade and risk of investments within the customer SEGs. Bloom , 846 F.3d at 247. Federal law, federal regulations, and Sentinels client agreements did, however, require all client funds to be segregated from each other as well from Sentinels House funds. (UBSs SoF ¶ 9) (citing 7 U.S.C. §§ 6d(a) and 6d(b) ; 17 C.F.R. §§ 1.3(gg), 1.20, 1.25, and 1.26(a) ).
As has been well documented in more than a dozen published and unpublished opinions dating back to 2009, Sentinel failed to abide by these rules.
In 1997, Sentinel opened up a line of credit-called the overnight loan-with the Bank of New York for the purpose of providing liquidity for customer redemptions and failed trades. In re Sentinel Management Group, Inc., 728 F.3d 660, 663-64 (7th Cir. 2013) ( BONY I ); (Trustees SoAF ¶ 11). Although Sentinel at certain points held well over $1 billion in customer assets, it kept very little cash on hand-never more than $3 million. BONY I , 728 F.3d at 663 ; (Trustees SoAF ¶ 12). This overnight loan from the Bank of New York allowed Sentinel to pay its redeeming clients in cash immediately, rather than after waiting for specific securities to sell. BONY I , 728 F.3d at 664 ; (see also Expert Report of Frances M. McCloskey (McCloskey Rep.), ¶¶ 64-67, Ex. 2 to UBS Securities, LLCs Response to Trustees SoAF [121-2] (UBSs Resp. to Trustees SoAF).) As acknowledged by the Seventh Circuit, the original overnight loan arrangement did not violate segregation requirements[:] When a customer cashed out, the amount needed in segregation dropped by the amount lent by the Bank via the line of credit. BONY I , 728 F.3d at 664.
Sentinel maintained two types of accounts with the Bank of New York to facilitate this arrangement: segregated accounts and non-segregated accounts. Nine segregated accounts held different asset classes-cash, government securities, and DTC (corporate) securities -for each of SEGs 1, 2, and 3. (Trustees SoAF ¶ 8.) The four non-segregated accounts included Sentinels House cash account, as well as several clearing accounts through which Sentinel bought, sold, and transferred securities. (Id. at ¶ 9.) Sentinel also maintained six additional segregated accounts for holding clients cash at JP Morgan, which will be discussed further below. (Id. at ¶ 10.)
Sentinels primary clearing accounts at the Bank of New York were called the SEN account and the SLM account. (Id. at ¶ 9.) These two accounts operated together to clear transactions and to secure the overnight loan from the Bank. (McCloskey Rep. ¶¶ 64-67.) The SEN account was the clearing account and only held securities or cash during the day. Every evening, Sentinel would zero out the SEN account and transfer securities to the night-time SLM account to secure the overnight loan. At some point, however, Sentinel began securing the overnight loan using the assets in all of the non-segregated accounts, not just the overnight SLM account. BONY I , 728 F.3d at 663.
Sentinels actual use of the overnight loan and its customers funds bore little resemblance to their purported uses. Bloom , 846 F.3d at 248. Instead of merely facilitating day-to-day liquidity, Sentinel used the overnight loan to purchase risky securities that did not comply with customers investment portfolio guidelines. Grede v. FCStone, LLC , 746 F.3d 244, 248 (7th Cir. 2014) ( FCStone I ). Most importantly, beginning in 2001 and increasingly by 2004, Sentinels management started using the proceeds of the overnight loan to fund its own proprietary repurchase arrangements. BONY I , 728 F.3d at 664. Repurchase arrangements, or repos, are transactions in which one party sells a security to another party with an agreement to repurchase the security later, with interest-effectively, another loan with the security acting as collateral. Bloom , 846 F.3d at 248-49 (The goal was to earn enough income from the additional investments to beat the cost of borrowing. This came with risks.) Sentinels habit of funding repos with the Bank of New Yorks loan resulted in highly leveraged portfolio. Id. If (and when) the stock market eventually turned, Sentinel would face losses from both the depreciation of its assets and the cost of borrowing. As described by the Seventh Circuit Court of Appeals in a related case:
Sentinel routinely used hundreds of millions of dollars in securities it had allocated to customers as collateral to support Sentinels own borrowing to pursue its leveraged trading strategy for its own benefit. It moved those securities out of segregation and into a lienable account at the Bank of New York, its main lender, putting customer property at risk for Sentinels benefit. As Sentinels leveraged trading increased, its outstanding debt ballooned, and it drew more and more on its customers assets to support its borrowing habit.
FCStone II , 867 F.3d at 772 ; see also Bloom , 846 F.3d at 249-50. The Seventh Circuit called this practice a flagrant violation of both SEC and CFTC requirements which left both SEG 1 and SEG 3 chronically underfunded. FCStone I , 746 F.3d at 248. Sentinels customers remained unaware of these machinations, as securities that were serving as collateral for the BONY loan continued to appear on customer statements as if they were being held in segregated accounts for their benefit even though Sentinel was routinely removing them from those accounts. Id.
By the summer of 2007, Sentinel no longer slouched toward bankruptcy; it careened. Bloom , 846 F.3d at 249. The crisis in the subprime mortgage industry spread to the economy as whole, and Sentinels repo counterparties reacted by pushing their now-worthless securities back onto Sentinel. In June and July 2007, two of Sentinels largest repo counterparties returned more than $400 million worth of securities to Sentinel, which forced Sentinel to borrow more heavily from the Bank of New York to compensate-always using its customers property as collateral. Id. ; FCStone II , 867 F.3d at 772. As the summer went on, Sentinel found itself unable to keep up with its customers redemption requests and BONYs demand for collateral to secure the loan. Id. On August 17, 2007, Sentinel filed for Chapter 11 bankruptcy protection. Sentinel had by then lost more than $600 million of its clients money, and owed BONY in particular $313 million it had secured with client property. Bloom , 846 F.3d at 245-49.
2. Fraudulent Interest Calculations
On top of the segregation violations, Sentinels officers misbehaved in an additional way:
by falsifying the interest earned on the investments in its customers accounts. Sentinels marketing materials stated that investors would receive interest based on a pro rata share of the interest earned only on the securities appearing on their daily customer statements. (Trustees SoAF ¶ 28); see also Bloom , 846 F.3d at 248. Customers were also assured that there would be no allocation of profits and losses across the different Seg accounts.
Bloom , 846 F.3d at 248. Sentinel did not keep its word. Instead:
Sentinel [ ] would calculate the interest earned by all securities, including those belonging to other Segments and the house pool. Sentinel would then guesstimate the yield its customers expected to receive on their groups securities portfolio, add a little extra so that the rate of return seemed highly competitive, and report the customers pro rata share of that amount, minus fees, on the customers statement.
FCStone I , 746 F.3d at 248 (emphasis in original). The Trustee alleges also that, in addition to falsifying the interest credited to each of the SEGs, Sentinels insiders kept for themselves a substantial portion of the interest yield accruing on Sentinels overall securities portfolio. (Trustees SoAF ¶ 28; 1/15/10 Expert Report of James S. Feltman (2010 BONY Feltman Rep.), ¶¶ 64-68., Ex. 1.B. to Trustees SoAF [112-1].)
Sentinels misleading method of reporting interest has been widely criticized in other lawsuits arising from Sentinels bankruptcy, on the same bases that the Trustee now cites in opposition to UBSs motion for summary judgment. (See Trustees SoAF ¶ 28; 2/8/13 Omnibus Expert Report of James S. Feltman (2013 Omnibus Feltman Rep.), ¶¶ 90-96, Ex. 1.A. to Trustees SoAF [112-1].) One of the Trustees expert witnesses, James Feltman, reviewed selected customer accounts from 2005 to 2007, and concluded that Sentinel allocated interest income to customers by groups at a rate of return that they made up, and which they expected would approximate the amount earned by securities reportedly held in each customers account. (2013 Omnibus Feltman Rep. ¶ 96.)
During the SECs civil enforcement case against Sentinel and its officers, VP Charles Mosley conceded the same point. SEC v. Sentinel Management Group, Inc. , No. 07-CV-4684, 2012 WL 1079961, at *16 (N.D. Ill. Mar. 30, 2012) (Kocoras, J.). Mosley admitted that Sentinel would pool the interest generated by the various portfolios, including the House Portfolio, and distribute that interest across the investors portfolios[, and] further admitted that the interest distributed to investors bore no relation to the interest that the investors securities had actually accrued. Id. Judge Kocoras granted the SECs motion for summary judgment based on this admission, finding that Mosley violated sections 17(a)(1)-(3) of the Securities Act, 15 U.S.C. § 77a et seq. , because he actively and knowingly participated in Sentinels scheme to defraud its investors, obtained money by means of Sentinels misrepresentations, and engaged in a course of fraudulent business. Id.
The same evidence supported Eric Blooms criminal conviction. On January 19, 2017, the Seventh Circuit affirmed Blooms convictions on eighteen counts of wire fraud and one count of investment fraud. Bloom , 846 F.3d at 246. The Court of Appeals concluded that the evidence was sufficient to support the jurys guilty verdict against Bloom on the allegation that he employed a scheme to manipulate client yield rates by reallocating interest ... in an effort to make the 125 Portfolio seem more lucrative that it was[.] Id. at 250. The Trustee highlights United States v. Bloom , 846 F.3d 243 (7th Cir. 2017), as particularly relevant to UBSs situation due to the effect Blooms yield manipulation had on SEG 1:
Sentinel used the yields from the house account and the Prime Portfolio [i.e., SEG 3] to inflate artificially the returns from the 125 Portfolio [i.e., SEG 1]. Sentinels high-risk trading in the house account generated higher returns than the more conservative 125 Portfolio. The Prime Portfolio, which was slightly riskier than the 125 Portfolio, likewise generated higher returns. Sentinel redistributed some of these returns from the house account and the Prime Portfolio to the 125 Portfolio, effectively using the riskier accounts to subsidize the more conservative account. With these inflated rates of return in the 125 Portfolio, Sentinel could attract new clients by outperforming its competition. Indeed, it advertised these rates in its marketing material and on its website.
Sentinel employees testified that they doctored the yield rates on a daily basis from 2004 until the companys bankruptcy in 2007. Instead of paying customers the interest they actually earned, Sentinel employees divvied up interest payments according to the instruction of Bloom or Charles Mosley. Bloom in fact created a spreadsheet to help employees calculate how to redistribute funds, which was called the Daily Yield/Rate Calculation. The spreadsheet listed both the actual interest earned by customers securities and the rate set by Sentinel.
The rate setting often favored the customers in Seg 1 (125 Portfolio). For example, on December 7, 2006, the interest actually earned by Seg 1 was $96,942.63. After the rate manipulation by Sentinel, that portfolio was allocated $103,832.46. On that same day, Seg 3 (Prime Portfolio) actually earned $148,005.09 in interest and the house account earned $17,949.85. After Sentinels rate adjustment, Seg 3 customers were paid just $112,657.32 and the house account received $49.11.
... [O]n July 30, 2007, Bloom spoke with an employee who was setting the rates and agreed to inflate the 125 Portfolio to keep it competitive. At the end of that day, Seg 1 actually earned $63,477.53, but was paid $100,420.34 using the interest earned by customers in Seg 3 and by the house account. Another employee testified that he raised the matter with Bloom before May 15, 2007, and Bloom acknowledged that Seg 3 and the house account supplemented Seg 1.
(Trustees Memorandum of Law in Opposition to UBSs Opening Br. [111] (Trustees Resp. Br.), 12) (quoting Bloom , 846 F.3d at 252.)
The Trustee has not submitted evidence regarding the specific securities that Defendant UBS was supposed to be earning interest on, nor on the exact difference between the interest UBS was allegedly overpaid and the real interest rate. Instead, the Trustee argues that because Sentinel was substantially undersegregated when it paid the $14.4 million in cumulative interest to UBS on March 30, 2007, it did not have sufficient funds to return all of its customers initial investments, let alone interest on those investments. (Trustees Resp. Br. 21-22.) Simply put, the Trustee asserts, there was no interest to pay UBS, and the entire $14.4 million therefore constitutes false profits. (Id. ; see also Complaint 18-19.)
UBS challenges this characterization of the interest earned on its SEG 1 account. (UBSs Opening Br. 8.) At the very least, UBS contends that the Trustee cannot possibly prove his blanket denial of the cumulative interests legitimacy: the Trustee has failed to plead or show any facts about the specific amount of alleged false profits transferred to UBS on each of the hundreds of days that UBS invested customer funds in Sentinel. (Id. at 12.) In a related dispute, Grede v. FCStone, LLC , No. 09-CV-136 (the FCStone test case), UBSs expert Frances McCloskey concluded that Sentinel acted appropriately when paying interest to its customers. (McCloskey Rep. ¶¶ 273-277.) McCloskeys analysis of the securities yields and returns paid to customers revealed that returns from securities on customer statements provided the overwhelming majority of the return paid to customers, but that customer returns in most groups were supplemented in small amounts by Sentinels House repo portfolio. (Id. at ¶ 274.) McCloskey found no instance in which Sentinel redirected returns from one SEG to another, rather than from Sentinels own funds to the customer SEGs. (Id. ) McCloskey also repeatedly emphasizes that Sentinel does not display any of the characteristics that define a Ponzi or Ponzi-like scheme, but was engaged in a legitimate business [ ] providing investment management to its customers. (Id. at ¶¶ 269-272.)
UBS also argues that the Trustee himself has conceded the legitimacy of the cumulative interest through earlier testimony from its expert James Feltman. (Id. at 12-14.) During his deposition in the FCStone test case, Feltman testified as follows:
Question: Was there anything improper with Sentinel accruing interest and allocating it to customers on a daily basis?
FELTMAN: Not from the standpoint of the process. The actual procedure that Sentinel used or the procedure that Sentinel used incorporated examining the entire portfolio of securities it held including interest on repos and taking into account the daily interest charges on the loan and putting that into the overall calculus on a gross and net basis, but at the end of the day Sentinel made, in my view, a significant attempt to match the interest accrued and allocated to customer accounts to the actual earnings that the securities would have reflected for those customers.
(Dep. of James Feltman in Grede v. FCStone, LLC , No. 09-CV-136 (FCStone Feltman Dep.), at 219:4-20, Ex. 22 to UBSs SoF [98-22].) Feltman stood by that conclusion when he testified at the FCStone trial. (UBSs SoF ¶ 30.)
The Trustee contends that this quotation was taken out of context, and that Feltmans deposition taken as a whole supports the position he took in his reports: that interest was fraudulently calculated and paid using the profits on the entire comingled pool, and that the manner in which Sentinel credited interest was designed to avoid suspicions about its illegal activity. (Trustees Resp. Br. 13.) Immediately after making the statement quoted above, Feltman pointed out that to the extent that withdrawals included interest earned by a customer, the actual payment of interest was made with comingled funds because those funds were repeatedly routed into and through the SEN clearing account. (FCStone Feltman Dep. 222:4-10) (discussing proof 14 of the 2013 Omnibus Feltman Report which states: Interest income was paid to customers with cash from the comingled [SEN account] or other customers deposits. Id. at 55.) The Trustee also notes Feltmans testimony in the FCStone bench trial. When asked about the interest payments, Feltman stated: I [ ] concluded that that the interest allocations were items that the company ... created and were not derived from the securities that were on that customer statement for the day; theyre estimates[,] ... what Sentinel thought their customers would expect; and that Sentinel allocated interest from the whole pool, not the securities identified on customer statements. (FCStone Trial Tr. 581:5-8, 589:10-12, 591:13-19.) The Trustee concludes that the portion of Feltmans deposition testimony offered by UBS merely shows that Sentinel tried really hard to appear legitimate-not that the alleged profits were not fraudulent. (Trustees Resp. Br. 25.)
3. UBSs Relationship with Sentinel and the March 2007 Transfer
Unlike many of Sentinels clients, UBS managed to withdraw its entire position in SEG 1 well ahead of Sentinels collapse.
The Trustee filed numerous avoidance actions against other SEG 1 investors who received funds on the days immediately surrounding Sentinels bankruptcy, see e.g. FCStone I , 746 F.3d at 252-54 (holding that various pre- and post-petition transfers were not avoidable); however, those transfers bear little resemblance to the one at issue here.
UBSs predecessor, ABN AMRO, Inc., had invested funds with Sentinel since 2000. (UBSs SoF ¶ 11.) UBS acquired ABN AMROs interest in Sentinel on September 30, 2016. (Id. at ¶ 16.) For the duration of its relationship with Sentinel, UBS was assigned to Group 7 of Sentinels SEG 1 portfolio. (Id. at ¶ 19.) Like that of all Sentinels clients, UBSs position was governed by an Investment Agreement that authorized Sentinel to purchase and sell securities for UBSs account and required Sentinel to hold those assets in segregation. (Id. at ¶ 11.) Under the terms of the Investment Agreement, UBS was entitled to redeem its investment at any time. (Id. at ¶ 14) (citing Investment Agreement § 4(b), Ex. 4.A. to UBSs SoF [98-4].)
On March 13, 2007-roughly six months after UBS acquired ABN AMROs interest in SEG 1-several UBS employees circulated an e-mail among themselves which contained internal analyses showing that UBSs investments with Sentinel were earning the highest monthly interest rate among five firms with which UBS had placed investments. (Ex. 40, E-mail from William Frothingham to Robert Gaffney, et al., of 3/13/07, Ex. 40 to Trustees SoAF [112-42]; UBS Investment Analyses, Ex. 41 to Trustees SoAF [112-43].) Two weeks later, on March 28, 2007, UBS employee Gregory Hardiman called Sentinels Sales Manager, Steven Stitle, to discuss pulling UBSs funds from SEG 1. (Trustees SoAF ¶ 31) (citing Administrator_BloomWAV_42A0, Ex. 42 to Trustees SoAF [112-44]; Transcript of phone call between Gregory Hardiman and Steven Stitle of 3/28/07 (Hardiman Call Tr.), Ex. 43 to Trustees SoAF [112-45].) Their conversation was recorded by Sentinel. Hardiman told Stitle that [UBS had] made a decision internally to exit the positions but that UBS would give Sentinel an opportunity to explain how Sentinel was earning their yields in the SEG 1 fund and consider re-entering the fund in the future. (Hardiman Call Tr. 2:9-12.) Stitle asked Hardiman if UBS had any specific concerns, and Hardiman replied that I think its more of a ... lack of understanding of [the] detailed positions. (Id. at 3:5-6.) Hardiman continued:
My understanding is [Sentinels] rates of return are fairly high relative to what anybody out there is getting at the moment[,] ... historically. Id like to understand how youre [ ] achieving that.... The perception would be youre taking more risk as a result, and Id like to understand what those risks are and where youre picking up your yields ... in the underlying portfolio.
(Id. at 5:2-13.) Stitle offered to put together a team probably with the CEO and myself and ... just shoot out there and do a little dog and pony show, but Hardiman insisted that any future presentation has to be specific to the portfolio and that he would like to see the portfolio manager in there ... explaining what hes doing and how. (Id. at 4:10-21.) Hardiman also provided a list of concerns he had regarding SEG 1:
What are the risks, what-where are you at within 125 [the 125 Portfolio, a.k.a. SEG 1], where are you getting the pickup and ... how. So are you going out double A, you know, going all ... the way out on the credit spectrum in terms of 125 and all the way out in terms of duration.... You know, what is it. And-and I believe wed like to understand that.
(Id. at 5:17-6:2.) Stitle assured Hardiman that those are questions we can answer fairly easily and that he would contact Hardiman again in a month to set up the presentation. (Id. at 6:16-19.)
Immediately after the phone call, Stitle e-mailed Eric Bloom and Charles Mosley stating:
Just got off the phone with Greg Hardiman @ UBS. They are pulling the $ $ $ because they are not comfortable with how we obtain the yields we post without incurring some unknown level of risk. Greg agreed to give us a chance to explain how we achieve this but is expecting a Q & A session in Stamford with you, me & Charles. I suspect the bulk of the questions will be directed to Charles.
Conversation was slightly more positive than I expected. Bottom line is that they cant stay invested in a vehicle that they dont fully understand & are [sic] comfortable with.
(E-mail from Steven Stitle to Eric Bloom and Charles Mosley of 3/28/07 (Stitle E-mail), Ex. 44 to Trustees SoAF [112-46].) The meeting never occurred. On March 30, 2007-two days after the call-UBS withdrew its entire stated account balance from Sentinel: $108,387,950.97. This amount included the $14,401,341.15 worth of cumulative interest credited to UBSs account that the Trustee now seeks to avoid. (Trustees SoAF ¶ 33.)
Later, in August 2007, Hardiman discussed the news of Sentinels then-recent collapse in an e-mail to a coworker: Hope people realize the value added by exiting the Sentinel fund ... Dont think people really appreciate/understand what could have been and the headache, potential issues/losses avoided here. People should be aware that we performed due diligence on the fund and made an informed decision to exit. (E-mail from Gregory Hardiman to Kevin Maloney of 8/16/07, Ex. 46 to Trustees SoAF [112-48].) In another e-mail summarizing UBSs financial position in light of the overall market downturn over the summer of 2007, Hardiman repeated his claim that [a]fter due diligence performed, we exited Sentinel in Q107, avoiding a potentially large loss. (E-Mail from Gregory Hardiman to James Buckland, et al., of 8/23/07, Ex. 47 to Trustees SoAF [112-49].) Another employee then talked up Hardimans work to others, stating: We inherited a $100mm placement with Sentinel with the ABN merger that Greg decided to exit in Q1 due to his concerns about the funds. (E-mail from John Laub to Daniel Coleman, et al., of 8/23/07, Ex. 48 to Trustees SoAF [112-50].)
The parties dispute the relevance and meaning of this evidence. The Trustee argues that these internal communications reveal Sentinels fraudulent intent when making the transfer, as the phone calls and emails establish that UBS was suspicious of the generous returns Sentinel was earning, and created an incentive for Sentinels managers to cover up their segregation violations and fraudulent interest calculations by paying UBS all of what Sentinel (wrongfully) said UBS was owed. (Trustees Resp. Br. 14-15.) UBS argues that the communications are irrelevant as they only speak to UBSs intent when requesting the transfer, and that, at best, they merely confirm that the reason UBS closed its account with Sentinel was because it was unfamiliar with Sentinel and did not fully understand Sentinels investment process. (UBSs Resp. to Trustees SoAF ¶¶ 31-34.)
In addition to providing Sentinel and UBSs internal communications regarding the transfer, the Trustee also supplies evidence regarding the origin of the money Sentinel used to pay UBS. The Trustee, through an expert witness, Anne Rasho Vanderkamp, claims that the money used to pay off UBSs account did not come from an account segregated for SEG 1. (Decl. of Anne Rasho Vanderkamp ¶ 5 (Vanderkamp Decl.), Ex. 45 to Trustees SoAF [112-47].) Rather, the money originated in a SEG 3 cash account-meaning that Sentinel paid UBS with other customers money. (Id. )
As mentioned above, Sentinel maintained six segregated cash holding accounts at JP Morgan in addition to its numerous accounts at the Bank of New York. (Trustees SoAF ¶ 10; McCloskey Rep. ¶¶ 53, 58-59.) The parties agree on most characteristics of these accounts. The JP Morgan cash accounts were non-transactional, meaning that their sole purpose was to hold customer cash in segregation. (Trustees SoAF ¶ 10.) Three of them were non-interest bearing; the other three did bear interest and were linked to a corresponding non-interest account. (McCloskey Rep. ¶ 58.) One of the non-interest bearing, segregated accounts was called the Sentinel Management Group, Inc. III-1.2 account, number 304-653403 (the JP Morgan SMG III account). (Id. ) On March 30, 2007, Sentinel transferred $120 million from the JP Morgan SMG III account to the SEN clearing account at the Bank of New York. (Trustees SoAF ¶ 33.) From there, Sentinel transferred $127.6 million from the SEN account to Sentinels SEG 1 segregated cash account at the same bank. (Id. ) Sentinel then wired the full $108,387,950.97 redemption payment from that cash account to UBS. (Id. ) The parties factual agreement ends there.
The Trustee alleges that the cash in the JP Morgan SMG III account (and its paired interest-bearing account) was supposed to remain segregated for the benefit of Sentinels SEG 3 customers. (Trial Tr. in Grede v. FCStone, LLC , No. 09-CV-136 (FCStone Trial Tr.), 205, 708, Ex. 4 to Trustees SoAF [112-4]; Deposition of Jeff Logan in SEC v. Sentinel Management Group, Inc. , No. 07-CV-4684 (SEC Logan Dep.), 202:10-203:10, Ex. 10 to Trustees SoAF [112-10].) UBS was not a SEG 3 customer. The Trustee claims that the other two sets of JP Morgan accounts were segregated for SEGs 1 and 2, respectively. (Id. ) The Trustee also claims that the March 30, 2007, cash transfers that facilitated Sentinels payment to UBS left SEG 3 undersegregated by $386,800,000-with just 45% of the assets allocated to SEG 3 on paper actually being held in segregation for the benefit of SEG 3s investors. (Vanderkamp Decl. ¶ 9.) After the transfer to UBS, SEG 1 itself was also left undersegregated by 29%. (Id. at ¶ 8.)
UBS responds that the Trustee mischaracterizes the nature of the JP Morgan accounts. UBS asserts that, despite the name SMG III, the JP Morgan SMG III account was open to cash from either of SEGs 1 or 3. (UBSs Resp. to Trustees SoAF ¶ 8.) While Sentinels internal account naming labeled that account as SEG 3 [or III], the account was not used that way. (Id. at ¶ 33.) Rather, SMG III was the third account opened with JP Morgan, and duplicates the role held by another account-number 323-961355, Sentinel Management Group, Inc.-1.20 (SMG 1.20)-which was already serving both SEG 1 and SEG 3. (Id. at ¶¶ 8, 33; McCloskey Rep. ¶ 58.) UBS asserts that the Trustees position represents a continued misunderstanding of the nature of Sentinels pro rata investment scheme: the Trustee fails to acknowledge that the key function of the daily allocation of securities [is] that all deposits on account are invested in a pool of securities, the composition of which is flexible from day-to-day in order to free up cash. (UBSs Resp. to Trustees SoAF ¶ 33) (citing McCloskey Rep. ¶¶ 100-112, 216-217.)
UBS supports its view of the true nature of the JP Morgan SMG III account with further evidence from its expert report by Frances McCloskey in the FCStone test case. According to that report, of the three sets of paired accounts at JP Morgan, only one set was reserved for a single SEG-and that set was titled Sentinel Management Group, Inc.-30.7 and segregated only for SEG 2 funds. (McCloskey Rep. ¶ 58) (stating that the accounts were so named because they were compliant with CFTC Rule 30.7 (i.e. for SEG 2 cash).) UBS also notes findings from a 2006 National Futures Association (NFA) audit of Sentinels accounts, in which the auditors acknowledged the pooling of SEG 1 and SEG 3 cash in the SMG 1.20 account but did not cite it as a violation requiring corrective action. (7/24/06 Summary of Audit Findings (July 2006 NFA Audit), Ex. 11 to UBSs Resp. to Trustees SoAF [122-1].) Examining much of the same evidence, Judge Zagel in the FCStone test case sided against the Trustee, and found that while one of the JP Morgan accounts was segregated for SEG 2, the other two non-interest bearing accounts and their interest bearing counterparts were available to be used for both SEG 1 and SEG 3 customer funds. Grede v. FCStone, LLC , 485 B.R. 854, 862 (N.D. Ill. 2013), revd on other grounds, FCStone I , 746 F.3d 244 (7th Cir. 2014).
Finally, UBS notes that several other Sentinel clients withdrew funds from Sentinel between February and April 2007. These other transfers were substantially smaller that UBSs, ranging in amount from $1.2 to $11.2 million, but UBS contends they demonstrate that the March 30 UBS transfer was simply business as usual. (UBSs SoF ¶ 22; UBS Securities, LLCs Reply in Support of its Motion for Summary Judgment [120] (UBSs Reply Br.), 13 n.5.) The early 2007 transactions occurred several months before Sentinels repo counterparties returned hundreds of millions of dollars worth of high-risk, illiquid securities and demanded hard cash in return-the event that ultimately brought down the firm. See FCStone I , 746 F.3d at 249-49 ; Bloom , 846 F.3d at 249. It is also undisputed that Sentinels officers remained substantially invested in Sentinel until at least the summer of 2007. (UBSs SoF ¶ 23.) On July 18, 2007, Chairman Philip Bloom suddenly withdrew $11.3 million, the majority of the funds in the [H]ouse account. Bloom , 846 F.3d at 253. CEO Eric Bloom likewise made unusual withdrawals in June and July 2007, giving himself an early bonus and retroactive raise in amounts totaling $250,000. Id. The timing of these insider withdrawals, UBS contends, also shows that no financial crisis or market pressure existed until months after UBSs withdrawal, when Sentinels repo counterparties pushed back the risky securities. (UBSs Reply Br. 23.) As a result, UBS claims, there is no evidence that Sentinel did anything unlawful or extraordinary to satisfy UBSs redemption request, or that it had a detrimental impact on Sentinels other customers. (Id. )
PROCEDURAL BACKGROUND
1. Early Bankruptcy Court Proceedings
Sentinel filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on August 17, 2007. After a flurry of early litigation and distributions authorized by the bankruptcy court, the relevant stakeholders approved a plan to liquidate Sentinels remaining assets on December 11, 2008. (Order Approving Chapter 11 Plan [1257] in In re Sentinel Management Group, Inc. , No. 07-BR-14987, 1.) The Liquidation Plan was approved over the objections of numerous SEG 1 investors (the SEG 1 Objectors), many of whom were later involved in the FCStone test litigation to sort out the issues arising under the Plan. Because UBS closed its account ahead of Sentinels bankruptcy, it never filed claims against the estate and so was not involved with the Plans approval. (UBSs SoF ¶ 31.) As a result, most of the provisions in the Liquidation Plan are not relevant to this dispute. UBS highlights one portion, however, as evidence that the Trustee should be judicially and collaterally estopped from challenging the legitimacy of the cumulative interest as false profits. (UBSs Opening Br. 21-24.)
At a hearing prior to the Plans approval, the Trustee argued in favor of computing customer claims based on account balances as of the last date customers saw them [August 13, 2007], minus any withdrawals that they had up through the petition date. (Transcript of Proceedings on 8/13/08 (8/13/08 Hearing Tr.), 35:13-16, Ex. 20 to UBSs SoF [98-20].) The Trustees proposal prevailed: the approved Liquidation Plan stated that [f]or the purposes of calculating Adjusted Percentage Recoveries and Percentage Recoveries, and for purposes of making Initial Distributions and establishing reserves, each Class 3 Customer Claim shall equal the amount listed as Net Equity on such Holders Customer Account Statements dated August 13, 2007. (Fourth Amended Plan of Liquidation [1251] in In re Sentinel Management Group, Inc. , No. 07-BR-14987 (Liquidation Plan), § 4.4.) Under this calculation, claims included the interest that appeared on customer accounts. (UBSs Opening Br. 21, 23.) UBS argues that the Trustee is therefore estopped from taking the wholly inconsistent position that the cumulative interest constituted false profits. (Id. at 22.)
The Trustee responds that UBS selectively misreads his testimony and misstates the actual terms of the Liquidation Plan. (Trustees Resp. Br. 30.) Neither his hearing testimony nor the Plan, the Trustee states, concede the legitimacy of the cumulative interest. (Id. ) Instead, the Trustee insists that his testimony addressed the limited question of whether initial distributions and reserves under the Plan would be calculated using a net investment methodology (based on the amounts invested and appearing on customer accounts) or a net equity methodology (based on the hypothetical liquidation value of the securities). (Trustees Resp. to UBSs SoF [114], ¶ 26; 8/13/08 Hearing Tr. at 32:17-36:2.) The Trustee claims that he argued for the net investment method because using the net equity alternative would have unfairly punished customers to whose accounts illiquid and valueless securities unlawfully had been allotted. (Trustees Resp. Br. 30.) Later at the same hearing cited by UBS, counsel for the Trustee explained:
[We] are talking about treating everybody equally, we are talking about the amount that they put into Sentinel. In this case the customer put $18.5 million into Sentinel. We are not talking about respecting the account statements that are completely fraudulent, that everyone in this courtroom knows were completely fraudulent.
On this day, this account statement said there was a bunch of junk in junk trading account. On a different day, it said something different. These are made up. So we are not treating everybody equally based on Eric Blooms lies to the customers. We are treating everybody based on what they put into the company.
(8/13/08 Hearing Tr. 176:19-177:8.)
The bankruptcy court ultimately approved the Trustees preferred net investment-based claim calculation over the objection of the SEG 1 investors. (Trustees SoAF ¶ 35.) The Trustee maintains, however, that his decision to support the net investment methodology cannot be interpreted as an admission to the accuracy of Sentinels customer statements-and therefore the cumulative interest. Rather, he only chose to utilize customer account balances because it was the most expedient and cost-effective method to make initial distributions given Sentinels extensive comingling of customer funds. (Trustees Resp. Br. 31); see also In re Sentinel Management Group, Inc. , 398 B.R. 281, 310-14 (Bankr. N.D. Ill. 2008). The Trustee claims that this understanding was built into the Liquidation Plan, and cites the mandatory Disclosure Statement referenced in the Plan, which reads in relevant part:
[A]s tested by the Plan Proponents over the three and a half year period of time preceding the Petition Date, the notional value that Sentinel reported to Sentinels Customers on its monthly account statements closely approximated Customers net investment Claim measured over the same period.... Given the proximity of the amount reported to Customers by Sentinel on their customer statements to their actual net investment (when provision is made for time value of money), and due to the unreliable and incomplete nature of Sentinels books and records (which would obfuscate any attempt to arrive at a perfectly accurate measurement of net investment), the Plan Proponents believe that the amount reported by Sentinel on Customers account statements is in fact the most efficient, equitable method to calculate Customer Claims.
(Disclosure Statement [592] in In re Sentinel Management Group, Inc. , No. 07-BR-14987, at 31.) UBS responds that whatever the Trustees reasons may have been, the Plans effect was to legitimize the cumulative interest. (UBSs Reply Br. 25) (emphasis in original).
2. The Present Complaint
On June 24, 2009, the Trustee filed the present adversary proceeding against UBS in bankruptcy court. (Complaint 22.) On November 4, 2009, Judge Zagel of this court entered an order withdrawing the reference of this dispute from the bankruptcy court. (11/4/09 Order, Ex. 24 to UBSs SoF [98-24].) UBS originally moved for summary judgment [32] in June 2012. Judge Zagel held that motion under advisement for several years as two related cases traveled back and forth on appeal. The case was reassigned to this court on April 25, 2017, after Judge Zagel took senior status. This court then struck UBSs summary judgment motion without prejudice and ordered the parties to re-brief the motion. (5/19/17 Status Hearing [92].)
The Trustees complaint against UBS alleged three counts in connection with Sentinels transfer of $14,401,342.15 in cumulative interest on March 30, 2007. Count I sought to avoid the payment as an actual fraudulent transfer under 11 U.S.C. § 548(a)(1)(A), Count II sought to avoid the same transfer as constructively fraudulent under Section 548(a)(1)(B), and Count III sought the disallowance of any claims that UBS had against Sentinels estate. (Complaint 18-22.) Based on the Seventh Circuits opinion in FCStone I and the lack of any claims by UBS against the bankrupt estate, the Trustee has admitted that the court should dismiss Counts II and III. (See Trustees Omnibus Response to Defendants 2012 Motions for Summary Judgment [36], 26; Trustees Sur-Reply to 2012 Motions for Summary Judgment [63-1], 5 n.3.) Only Count I, alleging an actual fraudulent transfer, remains at issue in UBSs motion for summary judgment.
Count I asserts that Sentinels managers acted with the actual intent to hinder, delay, or defraud Sentinels other investors. That claim rests on three core theories: (1) that the entire cumulative interest total consists of false profits; (2) that Sentinel made the transfer in order to cover up and perpetuate its fraud after UBS became suspicious of Sentinels business; and (3) that Sentinel made the transfer using funds belonging to a different class of investors. (Complaint 8-13; Trustees Resp. Br. 18-23.)
UBSs motion for summary judgment asserts that the Trustee alleges only a general scheme to defraud and that the Trustee has not established a genuine dispute of material fact as to Sentinels intent regarding the specific transfer at issue in this case. (UBSs Opening Br. 2-3.) UBS further argues that the Trustee is estopped from arguing that the interest paid to UBS was anything but genuine based on the results of-and the Trustees statements during-related litigation. Overall, UBS describes Count I as merely a poorly disguised preference claim that the Trustee pleaded as a fraudulent transfer in order to avoid the 90-day limitations period applicable to bankruptcy preference actions. (Id. at 3.)
DISCUSSION
1. Legal Standard
Summary judgment is appropriate when the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law. FED. R. CIV. P. 56. In ruling on a motion for summary judgment, the court views the evidence in the light most favorable to the non-moving party-here, the Trustee-and draws all reasonable inferences in the non-moving partys favor. Gillis v. Litscher , 468 F.3d 488, 492 (7th Cir. 2006) (citing Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 255, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986) ). A genuine dispute of material fact exists where the evidence is such that a reasonable jury could return a verdict for the nonmoving party. Carroll v. Lynch , 698 F.3d 561, 564 (7th Cir. 2012).
The Trustee sued to avoid Sentinels payment of $14.4 million in cumulative interest to UBS as an actual fraudulent transfer under 11 U.S.C. § 548(a)(1)(A). In order to prevail and claw back the $14.4 million to the liquidation trust, the Trustee must prove that Sentinel acted with actual intent to hinder, delay, or defraud its other creditors. Id. On a fraudulent transfer claim, [d]irect proof of actual intent to defraud is not required-indeed, it would be hard to come by-and a trustee can prove actual intent by circumstantial evidence. Frierdich v. Mottaz , 294 F.3d 864, 869-70 (7th Cir. 2002). Courts will often look to the badges of fraud as circumstantial evidence of intent. Id. The intent to defraud will be found if the circumstances indicate that the main or only purpose of the transfer was to prevent a lawful creditor from collecting a debt. King v. Ionization Intern., Inc. , 825 F.2d 1180, 1186 (7th Cir. 1987).
Sentinels intent when making the transfer is a question of fact. See id. This court recognizes that summary judgment ought to be used sparingly and with great caution in cases such as this one where subjective intent is a factor in the determination. Alexander v. Erie Ins. Exchange , 982 F.2d 1153, 1160 (7th Cir. 1993) ; see also Allstate Ins. Co. v. St. Anthonys Spine & Joint Inst. , No. 06 C 7010, 2010 WL 3274283, *3 (N.D. Ill. Aug. 17, 2010) (denying the defendants motion for summary judgment in an actual fraudulent transfer case). A district court is nevertheless not obliged to entertain a metaphysical doubt. Alexander , 982 F.2d at 1160. Even in cases involving subjective intent, summary judgment is not inappropriate where the undisputed facts make the outcome clear. Id. (affirming summary judgment where the evidence was not sufficient to permit a jury to conclude that the defendant possessed the subjective intent to defraud).
2. UBSs Legal Arguments
As a preliminary matter, UBS asserts that numerous legal doctrines apply to bar-either in part or in whole-the Trustees claim to avoid the cumulative interest transfer, regardless of the evidence. None of UBSs arguments are successful, although some do apply to narrow the scope of the courts inquiry. The court will address all of them in brief.
a. The Trustees new theories do not effectively amend the Complaint
UBS argues that summary judgment should be granted in its favor on the two new theories of recovery raised by the Trustee for the first time in his brief in opposition to UBSs motion for summary judgment. (UBSs Reply Br. 15.) UBS claims these two new theories are that (1) Sentinel was allegedly undersegregated at the time of the March 30 Transfer; and (2) funds for the March 30 Transfer allegedly came from a SEG 3 cash account. (Id. )
UBS is correct that a plaintiff is not free to assert wholly new claims in briefs opposing a motion for summary judgment. Shanahan v. City of Chicago , 82 F.3d 776, 781 (7th Cir. 1996). That is not what the Trustee has done here, however. The Trustees claim-that the $14.4 million transfer was made with fraudulent intent and must be avoided-remains the same. The Trustee pleaded the core facts of the transfer at issue, its amount, and specifically alleged that [s]ecurities were not segregated, and the investment returns were false. (Complaint ¶¶ 1, 61.) The Trustee has since discovered evidence of undersegregation and the source of the transferred funds, but this evidence does not contradict his core claim; it supplements his claim. Furthermore, even assuming that UBS is correct that the Trustees arguments are new theories rather than mere evidence, plaintiffs are not required to plead specific legal theories in their complaints. Avila v. CitiMortgage, Inc. , 801 F.3d 777, 783 (7th Cir. 2015).
Even post- Twombly , Bell Atlantic Corp. v. Twombly , 550 U.S. 544, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007), a plaintiff is not required to plead with precision legal theories or detailed facts. Benuzzi v. Bd. of Educ. of City of Chicago , 647 F.3d 652, 664 (7th Cir. 2011). Having pleaded facts sufficient to state a plausible claim for relief, the Trustee is within his rights in developing his case further through discovery and defending his claim with those facts at the summary judgment stage. See Vincent v. City Colleges of Chicago , 485 F.3d 919, 923 (7th Cir. 2007) (Factual detail comes later-perhaps in response to a motion for a more definite statement, ... perhaps in response to a motion for summary judgment.)
b. The Trustee is not estopped from arguing that the cumulative interest was fraudulent
UBS also argues that the Trustee is estopped from disputing the validity of the cumulative interest based on admissions by its expert, James Feltman, and by the Liquidation Plan. With respect to each of these issues, UBS has overstated its case.
First, UBS notes that during his deposition in the FCStone test case, Feltman acknowledged that Sentinel made a significant attempt to match the interest accrued and allocated to customer accounts to the actual earnings that the securities would have reflected for those customers. (FCStone Feltman Dep. at 219:4-20.) UBS urges that this admission is binding on the Trustee and defeats his claim that all of the interest earned by UBSs investments and credited to UBSs account over the course of several years constitutes false profits. (UBSs Opening Br. 13.) As the Trustee notes, however, UBS is taking this passage out of context. Feltmans testimony as a whole clearly establishes his view that he viewed Sentinels method of allocating interest to be fraudulent. (FCStone Feltman Dep. 222:4-10.) Feltmans two expert reports reinforce this idea at length (see 2013 Omnibus Feltman Rep. ¶¶ 90-96; 2010 BONY Feltman Rep. ¶¶ 64-68), and, most importantly, several courts have already found that Sentinels managers did, in fact, regularly falsify the interest they credited to customer account. See SEC v. Sentinel , 2012 WL 1079961, at *16 ; Bloom , 846 F.3d at 250-52 ; FCStone II , 867 F.3d at 789. Viewing Feltmans admission in the light most favorable to the Trustee, the court agrees with the Trustees interpretation of that testimony: that Sentinel tried really hard to appear legitimate." (Trustees Resp. Br. 25.)
As will be discussed in detail, the court concludes that Feltmans testimony does not prove exactly what the Trustee wants it to prove. For the purposes of UBSs estoppel argument, however, this cherry-picked portion of Feltmans deposition does not bar the Trustee from arguing that Sentinel fabricated the precise amount of interest credited to customer accounts.
UBSs second estoppel argument focuses on the Liquidation Plan advanced by the Trustee. The Liquidation Plan fixed customer claims by whatever amount was listed as Net Equity on their final account statement before Sentinel filed for bankruptcy-i.e., their account balance. (Liquidation Plan § 4.4.) This amount includes the cumulative interest sum that the Trustee now seeks to avoid. UBS argues that the Trustee may not insist that the interest is legitimate for the purposes of distribution to creditors under the Plan, but not for the pre-petition transfer to UBS. (UBSs Opening Br. 21.) Accordingly, UBS claims that the Trustee should be judicially and collaterally estopped from claiming that the cumulative interest sum constituted false profits in this case. (Id. at 22.)
Judicial estoppel applies to prevent parties from advancing arguments that contradict arguments they prevailed on in an earlier matter. Wells v. Coker , 707 F.3d 756, 760 (7th Cir. 2013). Collateral estoppel applies to bar relitigation of issues that were resolved in a previous lawsuit. Adams v. City of Indianapolis , 742 F.3d 720, 736 (7th Cir. 2014). The Trustee would be judicially estopped if his current position regarding the fraudulent nature of the cumulative interest transfer were clearly inconsistent with the position he took before the bankruptcy court. Janusz v. City of Chicago , 832 F.3d 770, 776 (7th Cir. 2016). The Trustee would be collaterally estopped if the question of whether Sentinel allocated fraudulent interest raises the same issue as the method of determining customer claims for purposes of liquidating the firm. Adams , 742 F.3d at 736. Neither the inconsistency required for judicial estoppel nor the identity of issues required for collateral estoppel is present in this case.
As with Feltmans testimony, UBS misinterprets the source material. The Liquidation Plan indeed uses customers account balances, but does so only in three limited contexts: calculating Percentage Recoveries, making initial distributions, and establishing reserves. (Liquidation Plan § 4.4.) Claims must also still be allowed under the Plan in order to be paid. In addition, the Trustee never argued that the interest was legitimate; instead, he took the position that, given the extensive commingling, the account statements served as the most expedient and cost-effective method to make initial distributions. (Trustees Resp. Br. 31.) In the hearing prior to the Plans approval, counsel for the Trustee nevertheless clarified that the account statements were completely fraudulent. (8/13/08 Hearing Tr. 176:19-177:8.)
It is also clear from that hearing that the focus of the debate was the choice between the Trustees net investment methodology and the SEG 1 Objectors preferred net equity method of setting claims. (Id. at 32:17-36:2.) Either one of these methods necessarily relied on Sentinels account statements for some purpose: for net equity, the specific securities allocated to each account would be relevant; for net investment, only the overall balance matters. See In re Sentinel Management Group, Inc. , 398 B.R. at 310-314. The bankruptcy court found net investment to be the superior method because it was relatively fairer to the investors at a point when asset tracing was considered impossible. Id. at 313-14. The approved Plans Disclosure Statement states outright that the account balances were an imperfect tool, and merely approximated a customers actual net investment as reflected in Sentinels unreliable and incomplete records. (Disclosure Statement 31.) Given this evidence, it is entirely consistent for the Trustee to use a figure that included cumulative interest in connection with liquidating Sentinel while recognizing that Sentinels procedures allocating that interest were fraudulent.
c. Entitlement to be paid is not an absolute defense
UBS also asserts that it was legally impossible for Sentinel to have acted with fraudulent intent when making the March 30 transfer, because it was merely complying with a redemption request that it did not initiate and was legally and contractually required to honor. (UBSs Opening Br. 2.) The repayment of an antecedent debt, UBS claims, cannot be a fraudulent transfer as a matter of law. (Id. )
UBSs position runs contrary to well-established Seventh Circuit case law. The court has long recognized that a transfer by a debtor to one creditor, even though for consideration, is still a fraud against other creditors if there is an intent to defraud. King , 825 F.2d at 1186 ; see also Scholes v. Lehmann , 56 F.3d 750, 757 (7th Cir. 1995) (discussing the theoretical differences between actual and constructive fraud). So long as the Trustee can raise a reasonable inference of actual fraudulent intent, the transfer may be avoided. Challenging this principle, UBS cites B.E.L.T., Inc. v. Wachovia Corp. , 403 F.3d 474 (7th Cir. 2005), for the proposition that where a debtor transfers funds to a non-insider third-party creditor in payment of an antecedent debt in an arms-length transaction, there can be no claim that the transfer was made with actual intent to hinder, delay, or defraud any [other] creditor of the debtor. (UBSs Reply Br. 3.) The facts in B.E.L.T. share many similarities with the situation here, but its holding did not create a bright line rule. The district court had dismissed the creditors complaint because it failed to plead fraud with particularity. B.E.L.T. , 403 F.3d at 478. The Seventh Circuit affirmed, finding that the plaintiffs complaint failed to allege facts that spoke to the debtors motive in paying the defendant, and, alternatively, failed to adequately demonstrate that the debtors behavior reflected recognized badges of fraud. Id. The Seventh Circuit did not abandon its earlier jurisprudence, and did not conclude that transfers to parties entitled to receive payment on account of an antecedent debt are per se legal.
UBS attempts to bolster its interpretation of B.E.L.T. with several lower court opinions from other districts- Matter of Loomer , 222 B.R. 618 (Bankr. D. Neb. 1998) ; In re Carrozzella & Richardson , 286 B.R. 480 (D. Conn. 2002) ; and In re Central Illinois Energy Co-op. , 521 B.R. 868 (Bankr. C.D. Ill. 2014) -but these too do not establish that one who holds a legitimate debt can never be party to a fraudulent transfer. Both the Central Illinois and Carrozzella opinions discussed a transferees legal entitlement to the funds it received, but both of those cases regarded claims of constructive fraud. Central Illinois , 521 B.R. at 873 ; Carrozzella , 286 B.R. at 491-92. Specifically, those opinions addressed whether forgiveness of an antecedent debt counted as reasonably equivalent value for a debtors transfer-a critical question in constructive fraud cases. Id. As noted by a bankruptcy judge in this district, [u]nlike constructively fraudulent transfers, the adequacy or equivalence of consideration provided for the actually fraudulent transfer is not material to the question of whether the transfer is actually fraudulent. In re H. King & Assocs. , 295 B.R. 246, 283 (Bankr. N.D. Ill. 2003) (quoting In re Cohen , 199 B.R. 709, 716-17 (9th Cir. BAP 1996) ). Loomer addressed both constructive and actual fraud, but, like B.E.L.T. , the question of actual fraud turned on whether the court could reasonably infer fraudulent intent from the standard badges of fraud in the face of the transferees right to be paid. Loomer , 222 B.R. at 623.
The Trustee agrees that the Commodity Exchange Act (CEA), 7 U.S.C. § 1 et seq. , the Illinois UCC, and UBSs contract with Sentinel all gave UBS the right to demand the return of its investment. (See Trustees Resp. Br. 26.) However, fraudulent conveyance law supersede[s] private-law definitions of legal entitlements.
Peterson v. McGladrey & Pullen, LLP , 676 F.3d 594, 599 (7th Cir. 2012). To hold otherwise would render the law meaningless: when a fraudulent transfer is at issue, the recipient usually has a right to the money. Id. In any event, the Trustees factual argument in support of his fraudulent transfer claim is that UBS was paid with other investors money. The CEA and Illinois UCC do not shield transfers of other investors money simply because the transferee had the general right to be repaid.
What B.E.L.T. and cases like it really state is that when a plaintiff lacks direct evidence of fraudulent intent and instead takes the indirect route of inferring fraud from the circumstances of the transfer, or from the badges, the transferees legal right to receive the transfer is strong evidence that the transfer was not made with the intent to defraud. B.E.L.T. , 403 F.3d at 477-78 (Plaintiffs have not pointed to any decision from Illinois (or any other state) that treats a comparable payment of a third-party creditor, which dealt with the debtor at arms length, as a fraudulent conveyance on the theory that paying an antecedent debt evinces actual intent ); see also Boston Trading Group, Inc. v. Burnazos , 835 F.2d 1504, 1510-11 (1st Cir. 1987) (describing an allegedly fraudulent transfers fit within one of three standard paradigms of actual fraud as significant, but not dispositive when determining fraudulent intent); In re Sharp Intern. Corp. , 403 F.3d 43, 54-56 (2d Cir. 2005) (adopting the First Circuits reasoning from Boston Trading ). Contrary to UBSs position, however, there is no presumption of legality in the face of actual evidence of a transferors intent to hinder, delay or, defraud. The transferees entitlement to the transfer is merely one additional piece of evidence for the factfinder to consider, not a complete defense.
d. The Seventh Circuits FCStone opinions do not bar the Trustees claim
In Grede v. FCStone, LLC , 867 F.3d 767 (7th Cir. 2017) ( FCStone II ), the Seventh Circuit held that former SEG 1 customer FCStone, LLC and a similarly-situated group of SEG 1 Objectors were entitled to sole ownership of a pool of reserve funds set aside under the Liquidation Plan. Id. at 783-84. The Trustee had sought to divide the reserve funds among all of Sentinels SEG 1 and SEG 3 customers. The court held that the funds the SEG 1 Objectors had invested in Sentinel were protected by statutory trusts and that SEG 1 Objectors were entitled to the benefit of reasonable tracing conventions (or fictions) in seeking the return of their investments. Id. Furthermore, the court found that the essentially unrebutted testimony of FCStones expert, Frances McCloskey, established that the SEG 1 Objectors could actually trace ownership of their funds and the securities Sentinel purchased for their accounts. Id. at 784.
In his reply brief, UBS contends this decision undermines the Trustees description of Sentinels business practices as a whole. Broadly speaking, the Trustee has asserted that Sentinels fraudulent practices consisted of: (1) issuing false customer statements that misrepresented the assets held in segregation; (2) engaging in very involved machinations of allocating [ ] its securities to create the impression that customer assets were segregated; (3) pledging customer assets as collateral for the overnight loan and using the proceeds for the benefit of its own leveraging trading strategy; and (4) calculating interest based on the total portfolio, rather than a SEG-by-SEG basis, and then manipulating the returns among its customers. (Complaint ¶¶ 42, 43, 55-60; Trustees Resp. Br. 6-13.) As a function of these practices, the Trustee contends, Sentinel treated all of its customers assets as a single undifferentiated pool belonging to Sentinel itself ... Securities were not segregated, and the investment returns were false. (Complaint ¶ 61.) UBS claims, however, that the Trustees characterization of Sentinels business practices is invalid after FCStone II , which, in UBSs view, flatly reject[s] the Trustees self-serving characterization of Sentinels alleged fraudulent scheme. (UBSs Reply Br. 10.) UBS urges the court to apply collateral estoppel based on FCStone II .
As UBS reads FCStone II , that case flatly rejected the Trustees characterization of Sentinels fraud on virtually all counts: among other things, its leveraged trading strategy, the purchase, sale and allocation of customer securities, the undersegregation of customer assets, the use of customer assets as collateral and Sentinels books and records. (UBSs Resp. to Trustees SoAF ¶ 12.) As the court understands that case, however, UBSs reliance on it as a panacea stretches the Seventh Circuits decision far beyond its intended meaning, and does not comport with the voluminous case law addressing Sentinels bankruptcy.
Indeed, the Seventh Circuit has already avoided one of Sentinels transfers as made with the intent to defraud. See BONY II , 809 F.3d at 964. More importantly, Sentinels managers are currently serving lengthy prison sentences for fraud. See Bloom , 846 F.3d at 258. Multiple courts-including the Seventh Circuit in FCStoneII -have observed that Sentinels managers committed the charged fraud by calculating interest on a portfolio-wide basis and subsidizing the returns to the more-conservative SEG 1 with interest properly due to the riskier SEG 3. FCStone II , 867 F.3d at 789 ; Bloom , 846 F.3d at 246-250 ; SEC v. Sentinel , 2012 WL 1079961, at *16. Those same courts also held that Sentinels bankruptcy was not solely due to a market driven liquidity crisis, as UBS asserts. (UBSs Resp. to Trustees SoAF ¶ 11.) See, e.g., Bloom , 846 F.3d at 250 (rejecting Eric Blooms argument that Sentinels losses were due to bad business practices ... and the more general decline in securities markets). For this reason, collateral estoppel does not apply to bar Trustees claim to avoid the cumulative interest paid to UBS, nor is the Trustee barred from arguing that Sentinel made the March 30 transfer using other investors money and with the actual intent to defraud its other investors.
FCStone II does change the landscape in some ways, however, as it throws shade on the Trustees contention that Sentinels entire business was fraudulent from at least 2004 onward. (See Trustees Resp. Br. 23; Trustees Sur-Reply Br. 5-8.) In addition to his core arguments regarding the March 30 transfer itself, the Trustee asserts that Sentinels habit of comingling assets renders all of its subsequent actions avoidable:
Because Sentinel was illegally comingling customer funds and using the proceeds of that unlawful activity and new investor deposits to pay redeeming customers, every redemption payment in and of itself constituted an intentional misrepresentation of fact with respect to the redeeming investors redemption rights; each redemption is based on the investors account statements falsely reflecting the segregation of securities for their benefit, and falsely reflecting profits attributable to the customers account.
(Trustees Resp. Br. 23) (emphasis in original). The Trustees arguments, and his Complaint, focus in large part on Sentinels overall business practices, not the March 30 Transfer. (See Complaint ¶¶ 11-80.) Here, however-and like UBS-the Trustee goes too far.
The Seventh Circuit explicitly rejected the Trustees claim of rampant non-segregation in FCStone II . In fact, the Seventh Circuit questioned the entire basis for the Trustees argument:
[T]he trustee continues to argue that FCStone relied on phony records and a fictional, arbitrary allocation process with no basis in reality. The trustee is arguing in essence that because Sentinel unlawfully used customer assets as collateral for its own borrowing, all of its records amount to nothing more than smoke and mirrors. The trustee also contends that Sentinels customer ledgers are unreliable because they do not show securities owned by the house (which seems unsurprising to us since these are customer ledgers), and because customer statements did not disclose the risk to customers from Sentinels use of their assets as collateral to support its own leveraged trading strategy. But the trustee cites no legal authority to show that these facts render Sentinels internal records meaningless, and he cites no record evidence to show that McCloskeys tracing analysis was flawed. In our view, McCloskeys forensic analysis therefore remains unrebutted.
All parties to this case agree that Sentinel broke the law by using client assets as collateral for its Bank of New York loan. (Two of Sentinels executives are serving prison sentences, after all.) But that fact does not mean that FCStone cannot prove what it owned. Sentinel risked customer assets by pledging them as collateral, but that misconduct did not affect McCloskeys ability to trace those assets. The fact that SEG 3 customers happened to be the last victims of Sentinels machinations does not confer upon the district court broad equitable discretion to remedy their injury at the SEG 1 customers expense.
FCStone II , 867 F.3d at 787-88 (emphasis in original). In ruling against the Trustee, the Seventh Circuit found that the Trustee was wrong to view Sentinels records as a complete fraud. That view rested on the Trustees experts review of irrelevant evidence: namely, records from the Bank of New York and Sentinels securities inventory, rather than Sentinels detailed customer ledgers. Id. at 786. Defendant FCStone also presented unrebutted evidence that maintaining a single clearing account was an industry-standard practice, id. at 787, that pooling customer assets within each SEG and granting pro rata shares of those pools were permissible activities, id. at 789, and, critically, that it was possible to identify the location of every security Sentinel purchased and allocated over the entire relevant timeframe. Id. at 786.
The Seventh Circuit also rejected the Trustees maxim that Sentinel had treated customer asserts as one undifferentiated pool, finding instead that
Sentinel exchanged customer deposits for a beneficial ownership interest in identifiable securities on a daily basis. The trustee makes much of the fact that securities allocated to customers often were purchased by Sentinel much earlier. But the fact that Sentinel used a buy-and-hold strategy for its securities is irrelevant. The process of converting cash deposits into identifiable securities was unaffected by whether Sentinel already owned the securities or purchased them on the open market in response to new customer deposits.
Id. at 789. The court reiterated, and FCStone conceded, that Sentinels managers improperly commingled and illegally pledged customer-owned assets as collateral. Id. at 785. However, the court did not find any [other] misappropriation of customer assets, and refused to hold that Sentinels day-to-day holding activities were somehow fictional or fraudulent aside from the specific situation addressed in the BONY litigation. Id. at 784-87 (The securities Sentinel sold to Citadel in August 2007 were (with limited exceptions) segregated for the benefit of SEG 1 prior to the sale.)
Collateral estoppel applies where an issue was actually litigated in a prior dispute, essential to the final judgment, identical to the issue in the later dispute, and where the party to be bound was fully represented. See Matrix IV, Inc. v. Am. Nat. Bank & Trust Co. of Chicago , 649 F.3d 539, 547 (7th Cir. 2011). The evidence the Seventh Circuit addressed in FCStone II is precisely the same as what is now presented to this court: UBSs McCloskey Report is the one the Seventh Circuit found compelling, and the Trustees Feltman reports have not been updated to rebut McCloskey in the meantime. Admittedly, the FCStone test case focused on the investors entitlement to reserve funds set aside under the Liquidation Plan, a matter not at issue here. See FCStone II , 867 F.3d at 771. The basis for the Seventh Circuits ruling in FCStone II , however, was that the Trustees characterization of Sentinels business was at odds with the undisputed evidence. Otherwise the court would have found asset tracing to be impossible. Contrary to the Trustees argument in this case, at least some of the issues addressed in FCStone II are identical to the issues advanced in this litigation. (See Trustees Sur-Reply Br. 5-8) (calling the issue of Sentinels business practices in this dispute merely similar to the practices at issue in FCStone ). The Trustee also claims that the Seventh Circuit did not reject Judge Zagels findings of fact (see id. at 6), but this misses the point. The Seventh Circuit explicitly stated that it disagreed with Judge Zagels legal conclusions stemming from and relating to those findings [of fact]. FCStone II , 867 F.3d at 788. This court concludes that the Trustee is collaterally estopped from claiming that Sentinels allocation process or records were fraudulent, or that Sentinel held its customers funds as a single, undifferentiated pool belonging to Sentinel itself. (Complaint ¶ 61.) For the purposes of this motion for summary judgment, any assertions of Sentinels fraudulent business practices are limited to (1) pledging customer assets as collateral for Sentinels misuse of the overnight loan and (2) misallocating interest revenue across SEGs.
3. The Evidentiary Record
As stated, the Trustee asserts three basic theories of Sentinels fraudulent intent as it relates to the March 30 transfer. The Trustees evidence purportedly shows that Sentinel paid UBS from an account holding other investors money, that UBS withdrew its funds only after becoming suspicious of Sentinels activities, and that all of the interest credited to customer accounts consisted of false profits. (Trustees Resp. Br. 18-23.) The Trustee buttresses his claim with evidence of Sentinels overall scheme of illegally comingling customer funds and using the proceeds of that unlawful activity and new investor deposits to pay redeeming customers. (Id. at 23.) The Trustee believes that this evidence establishes, or at the very least raises a genuine dispute, that Sentinel wrongfully transferred the property of another to UBS-the very definition of conduct that has the effect of preventing Sentinels creditors from their assets. (Id. at 21) (internal citation and quotation marks omitted).
Based on the entire body of evidence, viewed in the light most favorable to the Trustee, this court finds that no reasonable trier of fact could find that Sentinel acted with actual fraudulent intent when transferring the $14.4 million in cumulative interest to UBS.
a. Payment from a SEG 3 account
The parties agree that the money used to pay UBS came from the JP Morgan SMG III account, but disagree as to the accounts significance. The Trustee claims that the JP Morgan SMG III account was segregated for the sole benefit of SEG 3 investors. (Trustees SoAF ¶ 33.) If true, this would be strong evidence that Sentinel intended to defraud its other investors when it paid UBS; but the evidence does not support the Trustees position.
The Trustee and UBS both cite to their opposing expert reports to argue that the JP Morgan SMG III account was segregated for SEG 3 alone, or for SEG 1 and SEG 3 together , respectively. This court will not weigh expert opinions in ruling on a motion for summary judgment; however, UBS supplements its report with a critical piece of evidence. The NFAs 2006 audit explicitly recognized that Sentinel was permitted to hold SEG 1 and SEG 3 cash together in a single account at JP Morgan. (July 2006 NFA Audit.) The auditors recommendations specifically permitted SEG 1 and SEG 3 funds to remain in the same account, and stated only that SEG 2s funds needed to be held separately. (Id.) The JP Morgan SMG III account did not exist at the time of the audit, but it is undisputed that the SMG III account was a duplicate of the audited SMG 1.20 account and served an identical purpose. The account names are potentially confusing, but as UBS states, the account was not used that way. (UBSs Resp. to Trustees SoAF ¶ 33.)
Testimony by two different witnesses in the FCStone test case is also noteworthy. The Trustee claims that the trial testimony of Sentinel employee Jeff Logan militates in the Trustees favor, but that testimony is, at best, inconclusive: Logan stated only that he believed that the three JP Morgan cash accounts exactly corresponded to SEG 1, 2, and 3, and later admitted on cross examination that he wouldnt know anything that the NFA may have said regarding cash being held at JP Morgan. (FCStone Trial Tr. 205:13-24; 238:5-21.) Logan also effectively corroborated UBSs argument by admitting that Sentinel, at the very least, did hold SEG 1 and SEG 3 cash together in the SMG 1.2 account before the SMG III account existed. (Id. at 239:1-24.) Later during trial, James Feltman, the Trustees own expert, admitted on cross examination that SEG 1 and SEG 3 cash was held together in the JP Morgan accounts. (Id. at 708.)
Based on this very evidence, another court has already found the Trustees argument to be without merit. During a bench trial in which he otherwise ruled in favor of the Trustee, Judge Zagel made a finding of fact that [t]wo of the non-interest bearing accounts [at JP Morgan] and their interest bearing counterparts were available to be used for both SEG 1 and SEG 3 customer funds. The other non-interest bearing account and its interest bearing counterpart was used to hold SEG 2 funds. Grede v. FCStone, LLC , 485 B.R. at 862. Judge Zagels opinion was reversed on appeal, but to the extent the Seventh Circuit disagreed with his treatment of the facts, all of those issues were decided against the Trustee based on the essentially unrebutted report of Frances McCloskey. FCStone II , 867 F.3d at 784. McCloskeys same report serves as the evidentiary heart of UBSs current motion for summary judgment. That report successfully traced all of the cash and securities within Sentinels records (not only those assets allocated to SEG 1) for 2007 and did not find ... any evidence of misappropriation of customer assets apart from the segregation violations connected to the overnight loan. Id. at 785.
The Trustee offers new evidence that it claims disputes this finding. Specifically, the Trustee cites an expert report from Anne Vanderkamp to show that the money used to fund the transfer came from the JP Morgan SMG III account. (Vanderkamp Decl. 2.) Notably, the Vanderkamp report does not actually state that the account should have only held cash for SEG 3. (Id. ) Vanderkamp makes no representations as to the legal requirements governing the JP Morgan cash accounts. Rather, Vanderkamp simply, and without support, refers to the account as the SEG 3 cash account. (Id. ) (emphasis added). As the JP Morgan account statements she relied on show, that was not the name assigned to the account. (See Statement of Account, Ex. 1 to Vanderkamp Decl. [112-47] ) (listing the accounts name as Sentinel Management Group, Inc. III-1.2). Vanderkamps declaration does not establish that the funds in the JP Morgan SMG III account were undeniably segregated for the benefit of SEG 3.
Finally, the Trustee also argues that the facts supporting this avoidance action are essentially identical to the facts in his avoidance action against the Bank of New York, which led the Seventh Circuit to conclude that Sentinel acted with an intent to hinder, delay, or defraud creditors. (Trustees Resp. Br. 18.) The Trustee argues that the courts decision in In re Sentinel Management Group, Inc. , 809 F.3d 958 (7th Cir. 2016) ( BONY II ), established, as a matter of law, that actual intent includes unlawfully exposing creditors to a substantial risk of loss of which they are unaware. ( Id. ) The Trustee accurately describes the law, but the facts of BONY I are inapposite. The Seventh Circuit avoided the Bank of New Yorks liens and returned the securities to the bankrupt estate because Sentinel exposed its FCM clients to a substantial risk of loss of which they were unaware when it pledged funds that were supposed to remain segregated for the FCM clients as collateral for Sentinels overnight loans. BONY I , 728 F.3d at 668 (emphasis added). The critical factor in BONY I was that the unsegregated funds were pledged as collateral, not merely that they were moved out of segregation. Id. ; see also FCStone II , 867 F.3d at 788 (stating that Sentinel broke the law by using client assets as collateral and Sentinel risked customer assets by pledging them as collateral). The Trustee claims here that Sentinels transfer to UBS allegedly left SEG 3 undersegregated by almost $400 million. Assuming first that this statement is accurate-Trustees expert Vanderkamp appears to rely on the same Bank of New York account statements that the Seventh Circuit found unreliable in FCStone II (see BONY SEG Cash Account Statements of 3/30/07, Exs. 2 and 3 to Vanderkamp Decl. [112-47] )-it is not clear why undersegregation would be dispositive. Undersegregated does not mean insolvent. It only means that the funds were not where they were supposed to be. What was merely a necessary condition for finding fraudulent intent in BONY, the Trustee incorrectly asserts is a sufficient condition in this case. The court concludes that no reasonable jury could find based on this evidence that Sentinel paid UBS with cash that it was legally obligated to hold in segregation for the benefit of its SEG 3 customers. (Trustees Resp. Br. 19.)
As a final matter, the court also feels compelled to recognize the ill fit between the Trustees argument and his requested relief. The Trustee claims that all the funds used to pay UBS were in fact the property of SEG 3 investors. But if that were true, why then would the Trustee only seek to avoid a portion of the transfer? (See UBSs Reply Br. 17) (If the Trustee really believed that the funds ... actually belonged to SEG 3 investors, he would have sought to claw back the entire March 30 and not just the Cumulative Interest.) If the Trustees allegations had any support, he likely would have tried to claw back the full $108 million for the SEG 3 investors-not just the $14.4 million identified as interest.
b. UBS and Sentinel communications regarding the transfer
The Trustee claims that UBS only withdrew its funds from Sentinel after becoming suspicious of Sentinels business practices. (Trustees Resp. Br. 19.) In support of this idea, the Trustee cites the recorded phone conversation between a UBS employee and a Sentinel employee, as well as internal e-mails from both companies. UBS responds that the communications are irrelevant because they only reveal UBSs intent in requesting and receiving the transfer. (UBS Resp. to Trustees SoAF ¶¶ 31-34.) Notably, the Trustee himself makes no further references to these communications after introducing them, nor makes any real attempt to link them to his larger argument concerning Sentinels intent to defraud.
The communications represent the closest the Trustee comes to establishing direct mindset evidence of fraudulent intent. But the phone call and e-mails are insufficient to allow a jury to conclude that Sentinels managers acted with that intent. A jury could perhaps conclude that UBS was suspicious about Sentinels activities when it decided to withdraw its funds, but that does not shed light on the relevant question in this case: whether Sentinel had the intent to defraud. A transferees mindset regarding an allegedly fraudulent transfer is irrelevant unless the transferee is a corporate insider-which is not the case here. See, e.g., In re H. King & Assocs. , 295 B.R. at 283 (Where the transferee is an insider of the debtor and is in a position to control the disposition of property of the debtor, the transferees intent is imputed to the debtor.) Even if UBS had actual knowledge of fraud on the part of Sentinels managers, evidence that speaks only to UBSs intent as a recipient would not be sufficient for the Trustee to avoid the transfer as fraudulent. See Boston Trading , 835 F.2d at 1512 ; Sharp , 403 F.3d at 55.
The sole communication from inside Sentinel simply summarized the contents of the phone call: that UBS was not comfortable with how we obtain the yields we post but that UBS would give us a chance to explain. (Stitle E-Mail.) The e-mail concludes by stating that the [c]onversation was slightly more positive than I expected. Bottom line is that they cant stay invested in a vehicle that they dont fully understand and are [not] comfortable with. (Id. ) No reasonable jury could infer intent to defraud from this single, innocuous e-mail. The Trustee also fails to present any statements from Sentinel executives or employees that would suggest that any of Sentinels other redemption payments to customers were made with the intent to defraud.
At best, UBSs alleged suspicions are relevant only to the availability of the good faith defense. 11 U.S.C. § 548(c). But the court need not address such a defense unless the Trustee can establish that Sentinel acted fraudulently. In this way, the Trustees case is very different from his earlier avoidance action against the Bank of New York. In BONY I , the Seventh Circuit found that Sentinel had acted with fraudulent intent and then remanded the case for district court to determine whether the Bank of New York had inquiry notice of Sentinels fraud. 728 F.3d at 668 n.2. The Seventh Circuit did not overrule the good faith defense and find the transfer avoidable until the cases second appeal, BONY II . 809 F.3d at 961-64 (holding that the Bank of New York did not receive the transfer of assets as collateral in good faith). The Trustee has not yet established any fraud with respect to the March 30 transfer to UBS. The court notes that the fraud addressed in BONY I was specifically said to be Sentinels practice of pledging segregated funds as collateral for its personal loan. 728 F.3d at 667-68. That decision does not by itself establish a basis for concluding that Sentinels transfers to customers in accordance with their investment agreements are fraudulent as well. Based on this evidence, no reasonable jury could find that the main or only purpose of the transfer was to defraud Sentinels other customers, King , 825 F.2d at 1186, and not simply a response to UBSs demand for a return of its money.
c. False Profits
As has been discussed, Sentinel did not calculate or allocate interest properly. Instead of distributing interest within each SEG, Sentinel calculated interest revenue based on the interest earned by all securities, including those belonging to other Seg[s] and the house pool. FCStone I , 746 F.3d at 248. Sentinels managers would then guesstimate the yield its customers expected to receive on their groups securities portfolio, add a little extra so that the rate of return seemed highly competitive, and report the customers pro rata share of that amount, minus fees, on the customers statement. Id. This process, other courts have found, was directed at inflating the returns to the 125 Portfolio-SEG 1-at the expense of the Prime Portfolio-SEG 3. Bloom, 846 F.3d at 252. Sentinels managers also pocketed some of the interest revenue themselves. (Trustees SoAF ¶ 20.) UBS disputes this, but there is no real argument to be made to the contrary. Generally speaking, Sentinels managers inappropriately allocated interest in a manner which favored SEG 1-of which UBS was a member.
Nevertheless, the Trustee does not raise a genuine dispute of material fact that Sentinel paid UBS with the intent to hinder, delay, or defraud its other investors. The reason for this is clear. The Trustee does not argue that UBS merely received more than its fair share of interest; the Trustee argues that all of the $14.4 million in cumulative interest paid to UBS was false profits. (Complaint ¶ 81.) Simply put there was no interest to pay UBS. (Trustees Resp. Br. 22.) The numerous opinions regarding Sentinels bankruptcy, however, hold otherwise. The detailed calculations provided by the Seventh Circuit in Bloom , for example, show that the overall portfolio earned $263,879.60 on December 7, 2006, and that SEG 1 received $6889.82 more than its actual share. Bloom , 846 F.3d at 252. On July 30, 2007, well after the transfer to UBS and just two weeks before Sentinel filed for bankruptcy, SEG 1 actually earned $63,477.53, but was paid $100,420.34. Id. These figures show that SEG 1 received extra interest revenue, but defeat any suggestion that the interest did not exist. Even the Trustees expert witness does not support the Trustees claim to avoid the entire $14.4 million. James Feltman states numerous times that Sentinel indeed received interest on its investments, which it credited to the different SEGs on a regular basis. (2013 Omnibus Feltman Rep. 55-58.)
As stated, the Trustee has not provided any evidence regarding the specific securities that UBS should have been earning interest on, nor regarding the exact amount by which UBS was overpaid. Prior cases show that such overpayment was likely, but the undisputed evidence, including evidence submitted by the Trustee, shows that it was minor at best. (See FCStone Feltman Dep. at 219:4-20) (saying that Sentinel made a significant attempt to match the interest accrued and allocated to customer accounts to the actual earnings that the securities would have reflected for those customers.) The Trustee himself admits that Sentinel tried really hard to appear legitimate. (Trustees Resp. Br. 25.) No reasonable jury could conclude that the entire $14.4 million payment consisted of false profits.
Instead, the Trustee repeats his claim that Sentinel was undersegregated and that, accordingly, Sentinel did not have sufficient funds to return all of its customers initial investments, let alone interest on those investments. (Trustees Resp. Br. 21-22.) As stated, however, while the Trustee treats the two terms as synonymous, undersegregated does not mean insolvent. The Trustee asserts that Sentinel was insolvent-which necessarily meant its customer account were under-segregated, but provides no support for this claim, citing only to portions of its Complaint which do not suggest insolvency. (Trustees Sur-Reply Br. 16.) The Trustees Complaint also inaccurately alleges that Sentinels entire operation was merely a sham to cover up Sentinels treatment of the assets under its control as an undifferentiated pool-a theory the Seventh Circuit has rejected. See FCStone II , 867 F.3d at 789. Furthermore, the Trustees focus on undersegregation ignores Seventh Circuits other findings in FCStone II that the Trustees expert, Feltman, relied on inappropriate documents in crafting his opinions and that UBSs expert, McCloskey, did not find, after validating the accounting for all of Sentinels securities inventory for more than 200 business days, any misappropriation of customer assets beyond the times when Sentinel pledged customer assets as collateral to the Bank of New York. Id. at 785.
Based on the evidence, no reasonable jury could find that the entire $14.4 million in cumulative interest was money to which UBS was not entitled-and therefore raise the inference that it was transferred with the intent to defraud others. The Trustee has not, however, made any effort to prove the much more likely proposition that a portion of the transfer in fact belonged to others. It seems likely that the Trustee cannot identify what that sum should be. The Trustee suggests that discovery in this case has been limited, but the more than one hundred unique exhibits attached to the parties briefs on the motion belie that suggestion. Discovery on this particular matter may have stayed on and off pending the results of related cases, but the Trustee and his lawyers have already had the opportunity to take depositions, examine witnesses at trial, craft expert reports, and examine documents across the dozens of avoidance actions he has filed for the benefit of Sentinels estate over the past decade. In any case, if the Trustee believed that he was likely to uncover new evidence regarding this eleven-year-old payment, he should have filed a Rule 56(d) affidavit attesting to that evidence with the court. Instead, the Trustee only presents evidence of the general scheme to manipulate yield rates-which is not sufficient to establish Sentinels intent in regards to the specific transfer at issue.
d. Sentinels generally fraudulent scheme
Having examined and rejected the Trustees evidence as it purportedly relates to the March 30 transfer to UBS, the court finds that the Trustees claim ultimately rests only on a general allegation of fraudulent behavior. This, the Trustee suggests, is sufficient to survive summary judgment.
The Trustee cites Scholes v. Lehmann , 56 F.3d 750 (7th Cir. 1995), to argue that even if Sentinel has earned some interest on its investments, that fact would not insulate the transfer from avoidance. (Trustees Resp. Br. 22.) Scholes involved a defendant lucky enough to make money from a Ponzi scheme, and the Seventh Circuit found the transfers to the defendant avoidable. Scholes , 56 F.3d at 753-58. The court stated:
It is no answer that some or for that matter all of [defendants] profit may have come from legitimate trades made by the corporations. They were not legitimate. The money used for the trades came from investors gulled by fraudulent representations. [Defendant] was one of those investors, and it may seem only fair that he should be entitled to the profits on trades made with his money. That would be true as between him and [the owner] or [the owners] corporations. It is not true as between him and either the creditors of or the other investors in the corporations. He should not be permitted to benefit from a fraud at their expense merely because he was not himself to blame for the fraud. All he is being asked to do is to return the net profits of his investment-the difference between what he put in at the beginning and what he had at the end.
Id. at 757-58. Scholes , unlike this case, specifically involved a Ponzi scheme, and the defendant was an unwitting accomplice in that scheme: [defendant] argues (seemingly without realizing the implications of the argument) that by continuing to invest in Douglass corporations he kept them going longer. Yes, and the longer a Ponzi scheme is kept going the greater the losses to the investors. Id.
But Sentinel, as the Seventh Circuit has recognized, was not a Ponzi scheme. FCStone II , 867 F.3d at 789. Sentinel actually invested its customers funds and paid a return. The return was inflated (or deflated, as the case may be), but that does not render Sentinels entire business fraudulent in the manner of a Ponzi scheme. Sentinels business was not propped up by continuous influxes of cash, but by loans from the Bank of New York secured using its customers assets as collateral. Sentinels fraud, as the Seventh Circuit stated in FCStone II , did not extend to its day-to-day business of holding, investing, and selling securities for its customers. Id. at 786-89. It was limited to pledging customer assets as collateral for the overnight loan-which is not at issue in this case-and misallocating interest income-the effect of which the Trustee cannot prove here. There is no legal support for the Trustees sweeping statement that every redemption payment in and of itself constituted an intentional misrepresentation of fact. (Trustees Resp. Br. 23) (emphasis in original).
The facts of this dispute are much more similar to those addressed by the Seventh Circuit in B.E.L.T. In that case, the Seventh Circuit held that a plaintiff suing to avoid transfers from Lacrad International Corp. to an outside lender could not sustain his claim that the transfers were made with fraudulent intent, even though Lacrads CEO had committed fraud in the course of operating the business. B.E.L.T. , 403 F.3d at 476. Lacrads CEO was not running a Ponzi scheme, but overspending on corporate credit cards and laundering money from the company. Id. at 476. As with Sentinel, Lacrad collapsed under the weight of its debts, but Judge Easterbrook, writing for the court, observed that it was not the sort of situation in which a court could properly infer fraudulent intent based on the facts of the case:
Plaintiffs have not pointed to any decision from Illinois (or any other state) that treats a comparable payment of a third-party creditor (paying corporate insiders and their cronies is altogether different), which dealt with the debtor at arms length, as a fraudulent conveyance on the theory that paying an antecedent debt evinces actual intent to hinder, delay, or defraud any [other] creditor of the debtor.
Id. at 478. The underlying fraud involving false financial statements and concealed company instability did not automatically render all future transfers subject to avoidance, even though those transfers also may have made [Lacrad] thirsty for assets [and] reduced the time it could stay afloat. Id. at 478.
Other Circuit Courts of Appeals have ruled similarly to the Seventh Circuit, and stated that courts should be wary of fraudulent transfer claims which fail to fit the paradigms of actual intent to defraud. Boston Trading , 835 F.2d at 1510-11 (stating that courts should avoid confusing a fraudulent transfer with situations involving a form of initial dishonesty ... that itself happens to be called fraud); Sharp , 403 F.3d at 55 (refusing to avoid a payment on account of an antecedent debt, [ ] made to an outsider, and [when] there is no admission of subjective bad faith (if indeed that would matter)). Using language that mirrors the Seventh Circuits summary of the law in B.E.L.T. , the First Circuit described the three paradigmatic cases of actual fraud as (1) sham conveyances in which the debtor maintains control of or continues to benefit from the asset; (2) transfers to a friend, family member, or other entity in a special relationship with the debtor; and (3) transfers in exchange for illiquid assets meant to hinder a creditors efforts to collect. Boston Trading , 835 F.2d at 1508. No such transfers are at issue in this case.
Most district courts have been cautious in addressing the propriety of non-Ponzi scheme, non-insider transfers. Earlier, this court rejected UBSs argument that Carrozzella and Central Illinois supported the idea that transfers on account of antecedent debts are per se lawful, supra section 2.c. That argument goes too far, but those cases confirm the Seventh Circuits unwillingness to characterize such transfers as per se unlawful, either. See Carrozzella , 286 B.R. at 489-91 ; Central Illinois , 521 B.R. at 875 n.8 (In the absence of a Ponzi scheme or an insider transfer, it is hard to see how a debtors payment to a creditor, even if preferential, could be characterized as an actual fraud against other creditors.) (citing B.E.L.T. , 403 F.3d at 478 ).
The Trustee cites to a case from the Southern District of New York, In re Bayou Group, LLC , 439 B.R. 284 (S.D.N.Y. 2010). Bayou involved large-scale investment fraud, and the district court upheld the bankruptcy courts decision to avoid the firms transfers to outside investors. It was essential to honor every request for redemption in accordance with the investors expectation based upon the investors falsely inflated account statement, because failure to do so would promptly have resulted in demand, investigation, the filing of a claim and disclosure of the fraud. Id. at 305 (internal citation omitted). Consequently, the district court found, every redemption payment in and of itself constituted an intentional misrepresentation of fact with respect to the redeeming investors redemption rights based on the investors falsely inflated account statement. Id. (emphasis in original). The Trustee zeroes in on the in and of itself language, but the Bayou courts rationale does not control the outcome here. The Bayou court found that the firm had been operating a Ponzi scheme, or, at the very least, exhibited all of the essential elements of such a scheme, including wholly fictitious profits and the explicit inducement of new investors in order to pay off old investors. Id. at 294, 306-07. In this light, the court explicitly distinguished the facts of Bayou from the Second Circuits own version of the Seventh Circuits B.E.L.T. decision: In re Sharp International Corp. , 403 F.3d 43 (2d Cir. 2005). See Bayou , 439 B.R. at 294, 300-04 (stating that the fraud in Sharp relates to the manner in which Sharp obtained new funding from Noteholders, not Sharps subsequent payment of part of the proceeds to State Street. The $12.25 million payment was at most a preference between creditors[.])
Overall, this court is persuaded that expanding fraudulent transfer liability to this case, which does not, at minimum, exhibit Ponzi-like features, would far exceed the intent of the statute and the Seventh Circuits directives. See, e.g., In re Petters Co. , 499 B.R. 342, 350-51 (Bankr. D. Minn. 2013) (discussing B.E.L.T. and Scholes in the context of a Ponzi scheme and distinguishing B.E.L.T. s single withdrawal from a foundering debtors debt structure as lacking the continu[al] churning of investors and money and service of the subject transfer in furtherance of th[at] scheme that was present in Scholes ).
UBS states that the Trustees case is nothing more than a poorly disguised preference claim that would be otherwise barred because the transaction preceded the 90-day window. (UBSs Opening Br. 3.) The court finds it difficult to disagree. It is the Trustees view that UBSs luck at withdrawing its funds before the financial crisis hit seems too good to be true. Perhaps it is, but this is not enough to establish that any transfer to an investor during the relevant time is fraudulent. The Trustee anchors his claim on the hope that a jury will find Sentinels overall behavior suspicious enough to infer that this specific transfer was fraudulent. But general schemes are not sufficient: the Trustee is required to prove that the transfer itself was made with fraudulent intent. King , 825 F.2d at 1186. The Trustee has provided no relevant evidence of intent to defraud as it relates to the March 30 transfer to UBS. The evidence viewed in the light most favorable to the Trustee does not raise a genuine dispute as to Sentinels intent when making the transfer-rather, it supports UBSs position that Sentinel paid UBS on demand because Sentinel was required to. Certainly no adverse inference may be drawn from the mere fact that UBS redeemed its investment. And although the interest credited to UBSs account was likely overstated by some amount, the evidence does not support the Trustees belief that all $14.4 million constitutes false profits derived from a generally fraudulent scheme that never returned profits to investors. Nor is there any evidence that Sentinel paid UBS from a SEG 3 account or that Sentinel was insolvent in March 2007. Sentinels other transfers to redeeming customers around the same time and Sentinels officers continued involvement until the summer of 2007 further suggest that Sentinel was operating normally at the time of the transfer to UBS. As a result, this court concludes that no reasonable jury could find that Sentinel transferred the $14.4 million in cumulative interest with the actual intent to hinder, delay, or defraud its other investors.
CONCLUSION
For the reasons stated, the Defendants Motion for Summary Judgment [96] is GRANTED.
SEG 2 consisted of funds derived from FCM clients trades on foreign futures and foreign options markets. (Trustees Statement of Additional Material Facts in Opposition to UBSs SoF [112] (Trustees SoAF), ¶ 3.) SEG 2 funds are not at issue in this dispute.
See, e.g., SEC v. Sentinel Management Group, Inc. , No. 07-CV-4684, 2012 WL 1079961, at *1 (N.D. Ill. Mar. 30, 2012) (granting summary judgment for the SEC in its civil enforcement action against Sentinels Vice President Charles Mosley); In re Sentinel Management Group, Inc. , 809 F.3d 958, 964 (7th Cir. 2016) (BONY II ) (holding that BONY was on inquiry notice of Sentinels fraud and had received avoidable fraudulent transfers); Bloom , 846 F.3d at 245-46 (affirming Sentinel CEO Eric Blooms fraud convictions).
The DTC or Depository Trust Company is a securities depository used for clearing corporate-issued securities in the United States. (McCloskey Rep. ¶ 42.)
UBS asserts that only the SLM account was used to secure the overnight loan (see UBSs Resp to Trustees SoAF ¶¶ 9, 11), but UBSs own evidence does not support its claim. (See 5/17/06 NFA Audit Memo (May 2006 NFA Audit), 5, Ex. 16 to UBSs Resp. to Trustees SoAF [122-2] ) ([P]er Bloom, NFA noted that SEN can also be used as lien account.)
A repo is the transaction viewed from the sellers perspective, while a reverse repo is the same transaction from the viewpoint of the buyer. Sentinel was involved in both ends of these transactions: sometimes it used its customers cash to purchase securities, earning interest when it resold the security (lending); other times Sentinel sold securities to obtain cash quickly, repurchasing the security and paying interest afterwards (borrowing). Bloom , 846 F.3d at 248.
The SMG III account at issue in this case did not exist at the time of the 2006 audit, (see FCStone Trial Tr. 239:19-24, 708:1-13), but UBS asserts that it served an identical purpose as the SMG 1.20 account: holding both SEG 1 and SEG 3 cash. (McCloskey Rep. ¶ 58.)
The Trustee disputes that the funds actually belonged to the insiders or constituted an investment as opposed to the fraudulent proceeds of Sentinels unlawful leverage scheme, but acknowledges that the funds existed in the House account and were withdrawn on the stated dates. (Trustees Resp. to UBSs SoF [114], ¶¶ 23-24.)
Confusingly, the term net equity as a method of calculating interest and the term Net Equity as used on customer statements and in the Plan mean opposite things. Basing initial claim calculations off a customers Net Equity-in clearer terms, the account balance-was the result of the Trustees successful effort to calculate claims using the net investment methodology. A net equity method would not have utilized a customers account balance. (See generally Trustees Resp. Br. 30-31.)
In FCStone I , the Court of Appeals held that the Trustees constructive fraudulent transfer claims against other SEG 1 investors were barred by the safe harbor provisions in 11 U.S.C. § 546(e). 746 F.3d at 252-53.
The badges of fraud include:
[W]hether the debtor retained possession or control of the property after the transfer, whether the transferee shared a familial or other close relationship with the debtor, whether the debtor received consideration for the transfer, whether the transfer was disclosed or concealed, whether the debtor made the transfer before or after being threatened with suit by creditors, whether the transfer involved substantially all of the debtors assets, whether the debtor absconded, and whether the debtor was or became solvent at the time of the transfer.
Frierdich , 294 F.3d at 870 ; see also Grede v. Bank of New York Mellon , 441 B.R. 864, 881 (N.D. Ill. 2010).
The Seventh Circuit issued FCStone II on August 17th, 2017-after UBS filed its Motion for Summary Judgment. UBS raised argument for the first time in its Reply Brief, and the Trustee was afforded leave to file a Sur-Reply to respond to the new argument. (See Trustees Sur-Reply in Opposition to UBSs Motion for Summary Judgment [130] (Trustees Sur-Reply Br.), 2-3.)
The court recognizes that in BONY I the Seventh Circuit quoted Judge Zagels findings of fact to state that Sentinel handled its and its customers assets as a single, undifferentiated pool of cash and securities. 728 F.3d at 663 (quoting Grede v. Bank of New York Mellon , 441 B.R. at 874.) This finding, however, was mere background information not essential to the courts judgment. FCStone II did not overrule BONY I , but given that the Seventh Circuits more recent statement discussed evidence that was not available during the BONY trial and offered a more detailed investigation of the issue, this court considers itself bound by the Seventh Circuits final statement on the matter.
The court recognizes that other, unrelated fraud did occur. Sentinel CEO Eric Bloom was also convicted on the theory that he scheme[d] to solicit and accept new funds during Sentinels final days without revealing that the company was on the brink of bankruptcy, but that conduct occurred well after the March 30 transfer to UBS. Bloom , 846 F.3d at 250-54 ([Bloom] was charged with fraud only for the funds Sentinel received during its last business week.).
Even this conclusion would be a stretch in light of the evidence the Trustee cites. UBSs internal investment analysis indeed revealed that Sentinel had the highest return among the five rates UBS compared, but Sentinels returns were only 0.09% higher than the second best yield and 0.27% higher than average yield. (UBS Investment Analyses.) This difference may perhaps be significant, but it is hardly obvious grounds for suspicion.