Grede v. FCStone, LLC, 485 B.R. 854

Background

Sentinel filed for Chapter 11 in August 2007 and the Trustee sued for avoidance/recovery of transfers to FCStone in approximately $15.6 million in October 2008.
Sentinel operated multiple SEG portfolios for customers and maintained a complex pool under a pooled investment model with commingled cash and securities.
Sentinel’s assets were funded and maintained across BONY and JPMorgan accounts, including three BONY segregated cash accounts and several securities accounts; SEN and SLM accounts managed daily settlements and collateral.
Sentinel used a BONY overnight loan secured by collateral, increasingly leveraging its portfolio to support a large repo-based trading strategy, causing segregation shortfalls that grew from about $150 million to over $800 million.
In 2007, a Citadel securities sale (the Citadel Sale) yielded proceeds that Sentinel sought to distribute to SEG 1 customers; FCStone received a portion of those proceeds.
The court found competing federal trusts (CEA for SEG 1 and IAA custody rule for SEG 3) and applied Cunningham’s equity principle to determine pro rata distributions where assets were insufficient to satisfy all trust beneficiaries.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Property of the estate	Citadel proceeds were trust property under CEA/§541(d) and hence property of the estate.	Citadel proceeds were not property of the estate due to trust privacy/ Begier-style reasoning and comingle rules.	Citadel proceeds are property of the estate under §541.
Trust law framework for competing beneficiaries	SEG 1 and SEG 3 funds are protected by respective federal trusts (CEA and IAA), creating competing beneficiaries.	One trust should trump the other, or tracing isn’t required; CEA trust should prevail over IAA.	Co-equal trust claims require applying common law tracing rules; neither trust overrides the other absent precise tracing.
Tracing requirements	Tracing should identify specific trust property to exempt Citadel proceeds.	Tracing fiction may be used or not required due to Begier/ Begier-like nexus.	Tracing fictions not applied; cannot trace Citadel proceeds to Group 7 deposits; proceeds remain in trust and are not exempt.
Section 546(e) safe harbor applicability	Safe harbor may shield the defendant from avoidance of the distribution, given connection to securities contracts.	Safe harbor applies to shield the distribution; otherwise market ripple effects would occur.	Section 546(e) does not apply to this case; safe harbor does not permit avoidance of the Citadel proceeds.
Initial transferee and beneficiary status	FCStone was the initial transferee and beneficiary; dominion/control over funds existed.	FCStone acted as a conduit and did not exercise dominion; not initial transferee.	Defendant was the initial transferee and the entity for whose benefit the transfer was made.

Key Cases Cited

Begier v. United States, 496 U.S. 53 (1990) (trust property concepts in trust-fund contexts; Begier facilitates nexus-like tracing)
Cunningham v. Brown, 265 U.S. 1 (1924) (equality in distribution; tracing fiction limitations in commingled funds)
Bonded Financial Services, Inc. v. European Am. Bank, 838 F.2d 890 (7th Cir. 1988) (dominion and control test for initial transferee status)
In re Dameron, 155 F.3d 718 (4th Cir. 1998) (distinguishes tracing in Dameron context; discussing tracing approach)
In re Michigan Boiler and Engineering Co., 171 B.R. 565 (Bankr. E.D. Mich. 1993) (equitable distribution of commingled trust funds; pro rata approach)
SEC v. Wealth Management, LLC, 628 F.3d 323 (7th Cir. 2010) (Cunningham-based pro rata distribution; equities in trust claims)
In re Sentinel Management Group, Inc., 398 B.R. 281 (Bankr. N.D. Ill. 2008) (coordination of CEA/IAA trusts and application to Sentinel case)
In re Enron Creditors Recovery Corp., 651 F.3d 329 (2d Cir. 2011) (settlement/avoidance implications of §546(e) in securities context)