IN THE MATTER OF: LEHMAN BROTHERS, INC., Debtor, CARVAL UK LIMITED, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation, Claimant-Appellant, —v.— JAMES W. GIDDENS, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., SECURITIES INVESTOR PROTECTION CORPORATION, Appellees.
Docket No. 14-890
UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
Decided: June 29, 2015
August Term, 2014 (Argued: February 26, 2015)
The appellant in this case seeks protection under the Securities Investor Protection Act (“SIPA“) as a “customer” of the failed broker-dealer Lehman Brothers. The appellant‘s predecessor entered into a series of repurchase agreements, which involved the sale of securities to Lehman, coupled with an agreement to repurchase the securities back from Lehman at a future date. Before the securities could be repurchased, Lehman failed and entered liquidation under SIPA. We conclude that the appellant is not a customer for purposes of SIPA because our precedents require that a customer must have “entrusted” assets to a failed broker-dealer, and the repurchase agreements did not involve any entrustment of assets to Lehman. We accordingly AFFIRM the district court and bankruptcy court orders denying the appellant customer status in Lehman‘s SIPA liquidation.
LUC A. DESPINS (Bryan R. Kaplan, on the brief), Paul Hastings LLP, New York, New York, for Claimant-Appellant.
MICHAEL E. SALZMAN (James B. Kobak, Jr., Beatrice Aisha Hamza Bassey, Savvas A. Foukas, Kathleen A. Walker, on the brief), Hughes Hubbard & Reed LLP, New York, New York, for Appellee James W. Giddens, as Trustee for the SIPA liquidation of Lehman Brothers Inc.
KENNETH J. CAPUTO (Josephine Wang, on the brief), Securities Investor Protection Corporation, Washington, D.C., for Appellee Securities Investor Protection Corporation
This case presents the challenging task of fitting a decades-old statute to a financial arrangement of more recent vintage. Enacted in 1970, the Securities Investor Protection Act (“SIPA“) seeks to protect investors who have entrusted their assets to a broker-dealer. If the broker-dealer runs into financial trouble, SIPA authorizes the speedy return of investors’ property and ensures that investors will be made whole if the assets are lost. In this case, we must consider how SIPA treats an investor who delivered securities to a broker-dealer as part of a now-common financial transaction known as a repurchase agreement. We conclude that an investor who delivers securities to a broker-dealer as part of a repurchase agreement is not protected by SIPA because the investor did not entrust assets to the broker-dealer.
BACKGROUND
A repurchase agreement—commonly known as a “repo“—involves a matched purchase and sale. First, the “seller” agrees to sell assets, usually
Viewed from the seller‘s perspective, repos offer a mechanism for converting idle securities into liquid cash for a limited period. The seller can then employ that cash for investments or other purposes, before returning the cash to the buyer in exchange for the securities at the conclusion of the repo. Viewed from the buyer‘s perspective, repos provide an outlet for excess cash, and for the temporary acquisition of attractive securities. Moreover, because the resale price is higher than the original sale price, the buyer retains the difference—known as the “repo rate“—as a fee for the transaction. When viewed from a buyer‘s perspective, the transaction is called a “reverse repo.”
Between January 2000 and May 2001, Doral Bank and Doral Financial Corporation (collectively, “Doral“) entered into six repurchase agreements, with
After Lehman entered into SIPA liquidation on September 19, 2008, Doral submitted timely claims asserting that it was entitled to recover this profit. The SIPA Trustee denied these claims, concluding that Doral was not a “customer” of Lehman, and therefore was not protected by SIPA. Doral promptly objected to the Trustee‘s denial, but shortly thereafter transferred its claims to CVF Lux Master S.a.r.l. pursuant to
DISCUSSION
This appeal turns on a single issue: was Doral a “customer” of Lehman for purposes of SIPA? If Doral was a customer of Lehman, then under SIPA the appellant is entitled to the prompt return of any property that Lehman was holding on Doral‘s behalf—i.e., the securities that Lehman never resold to Doral as required by the repurchase agreements, less the contractual repurchase price. Conversely, if Doral was not a customer of Lehman, then the SIPA door is closed, and the appellant is relegated to pursuing a claim for those unreturned securities in the ordinary course of Lehman‘s bankruptcy proceedings. We begin our analysis of this question by first reviewing the principles articulated by our SIPA caselaw. We then turn to how these principles treat repurchase agreements. We
I. The Securities Investor Protection Act of 1970
Congress enacted SIPA in 1970 in response to “a business contraction [in the securities industry] that led to the failure or instability of a significant number of brokerage firms.” Sec. Investor Prot. Corp. v. Barbour, 421 U.S. 412, 415 (1975). These failures sent shockwaves through the securities market as investors who had handed their assets over to broker-dealers suddenly lost access to their property. Existing bankruptcy safeguards did not adequately protect investors because investor assets were frequently commingled with the broker-dealer‘s
SIPA was designed “to arrest this process, restore investor confidence in the capital markets, and upgrade the financial responsibility requirements for registered brokers and dealers.” Id. To accomplish these goals, SIPA created special procedures for the liquidation of failed broker-dealers. SIPA trustees administer what is in effect a “bankruptcy within a bankruptcy” for investors who had property on account with the broker-dealer. See
But a claimant only gets these special protections if it is a “customer” of the broker-dealer. SIPA defines a customer as:
any person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.
Beginning with SEC v. F. O. Baroff Co. we have consistently emphasized that to be a customer under this definition, an investor must have “entrusted” property to the broker-dealer. 497 F.2d 280, 283 (2d Cir. 1974). In Baroff, the
On appeal, we explained that the claimant was not a customer because he never entrusted assets to the broker-dealer. “Both the legislative history of [the definition of ‘customer‘] and its use since enactment have stressed protection to, and equality of treatment of, the public customer who has entrusted securities to a broker for some purpose connected with participation in the securities markets.” Id. at 283. The claimant in Baroff, by contrast, had lent the securities to the broker-dealer to bolster the broker-dealer‘s financial situation, rather than to trade on the claimant‘s own account. Because the securities had not been handed over for the broker-dealer to use for business on the claimant‘s behalf, the loan lacked “the
In the decades since Baroff, our cases have consistently hewed to this entrustment requirement for protection under SIPA. See, e.g., In re New Times, 463 F.3d at 128; Sec. Investor Prot. Corp. v. Exec. Sec. Corp., 556 F.2d 98, 99 (2d Cir. 1977) (per curiam). Most recently, in In re Bernard L. Madoff Investment Securities LLC, we reaffirmed that the “critical aspect of the ‘customer’ definition is the entrustment of cash or securities to the broker-dealer for the purposes of trading securities.” 654 F.3d 229, 236 (2d Cir. 2011) (further internal quotation marks and alterations omitted). Several of our sister circuits have also joined us in requiring that a claimant show that it entrusted property to a broker-dealer to qualify as a customer. See, e.g., In re Brentwood Sec., Inc., 925 F.2d 325, 327 (9th Cir. 1991) (“[The] definition [of customer] embodies a common-sense concept: An investor is entitled to compensation from the SIPC only if he has entrusted cash or
II. Entrustment
Recognizing that it must satisfy this entrustment requirement, the appellant contends that repurchase agreements necessarily involve entrustment. The appellant attempts to characterize our entrustment precedents as requiring SIPA claimants to “show that they delivered securities or cash to the broker-dealer ‘for some purpose connected with participation in the securities market.‘” Appellant‘s Br. 28 (quoting Baroff, 497 F.2d at 283). Doral met this standard, appellant argues, because Doral delivered assets to Lehman when it sold the securities during the first phase of the uncompleted repurchase agreements.
But mere delivery is not entrustment. Entrustment, as contemplated by Baroff, must bear “the indicia of the fiduciary relationship between a broker and his public customer.” 497 F.2d at 284. This “fiduciary relationship,” in turn, arises out of the broker‘s obligation to handle the customer‘s assets for the customer‘s
Under this framework, Doral did not entrust anything to Lehman. Instead, it sold the securities to Lehman, which acquired full legal title. See J.A. 479 ¶ 8 (paragraph of the MRAs providing that “[a]ll of Seller‘s interest in the Purchased Securities shall pass to Buyer on the Purchase Date and, unless otherwise agreed by Buyer and Seller, nothing in this Agreement shall preclude Buyer from engaging in repurchase transactions with the Purchased Securities or otherwise selling, transferring, pledging or hypothecating the Purchased Securities“). At most, Doral retained a contractual right to repurchase the securities at the
In the meantime, however, Lehman owned the securities, and could do what it wanted with them. As the district court correctly found, Doral‘s repos share many, if not most, of the characteristics that Baroff focused on in finding that the claimant there did not entrust securities to his broker-dealer:
[Lehman] did not sell the Purchased Securities to facilitate further securities trading on behalf of [Doral] or use the Purchased Securities to make margin purchases of further securities on behalf of [Doral]. [Doral] had no reasonable expectation that [Lehman] would sell or use the Purchased Securities in the near future for these purposes on behalf of [Doral]. . . . [Lehman] had acquired title to the Purchased Securities through the Agreements and, as was its right, used the Purchased Securities as collateral or for other repurchase agreements.
In re Lehman Bros. Inc., 506 B.R. at 354. Lehman‘s discretion to use the securities as it saw fit extended even to situations where Lehman and Doral‘s interests would become adverse. For example, if at the time of repurchase the securities are worth less than the contractual repurchase price, then Doral‘s obligation to repurchase would be “out-of-the-money,” and completing the sale would inflict a net loss on
In short, Lehman and Doral were arms-length contractual counterparties, and each entered into the repos for its own benefit. Because Lehman was acting for its own interests, it had no obligation to use the securities on Doral‘s behalf, and its relationship with Doral thus bore none of “the indicia of the fiduciary relationship between a broker and his public customer.” Baroff, 497 F.2d at 284. And without these indicia of a fiduciary relationship, we cannot say that Doral entrusted securities to Lehman.
This conclusion aligns us with the Eleventh Circuit, the only other circuit to expressly consider whether repurchase agreements involve entrustment. In re ESM Gov‘t Sec., Inc., 812 F.2d 1374 (11th Cir. 1987) (”ESM“), dealt with a failed
The Eleventh Circuit denied the claimant customer status. Citing Baroff, the ESM court explained that “it is the act of entrusting the cash to the debtor for the purpose of effecting securities transactions that triggers the customer status provisions.” Id. at 1376 (alterations omitted). Accordingly, a customer‘s claim must “bear the indicia of [a] fiduciary relationship” rather than “an ordinary debtor-creditor relationship.” Id. (internal quotation marks omitted). The Eleventh
The Eleventh Circuit‘s analysis applies with equal force to Doral‘s repos here. As explained above, Lehman was “not holding [securities] that rightfully belonged to” Doral. Instead, Lehman owned the securities, subject only to its contractual obligation to resell the securities at the end of the repos. Until the repos ended, they continued to belong to Lehman, not Doral. Accordingly, as in ESM, Doral‘s relationship with Lehman did not have the hallmarks of the fiduciary relationship between a customer and its broker-dealer.
The appellant tries to evade this conclusion by invoking Lehman‘s supposed general fiduciary duty to consummate the repurchase agreement. But, here, the repurchase agreements imposed, at most, a contractual obligation on
More generally, the appellant argues that the securities were entrusted because Doral retained a continuing economic interest in the securities even after they were sold to Lehman. The appellant cites several features of the repo transactions to show that Doral had an economic interest in the securities. First, of course, was Doral‘s expectation that it could repurchase the securities at the conclusion of the repos. According to the appellant, the repurchase agreements were, from Doral‘s perspective, less a sale of the securities than a temporary parting with assets that remained, fundamentally, its property. Second, Doral‘s books accounted for the securities as if it still owned them; conversely, Lehman‘s books did not treat the securities as property of Lehman. See J.A. 2128-29, 2757-928. Third, because Doral expected to pay a fixed contract price for the securities
For all these reasons, the appellant contends that Doral retained a significant economic interest in the securities, even though the securities were formally owned by Lehman, and thus that Lehman must have had some obligation to act on Doral‘s behalf in advancing that interest. In its strongest form, the appellant appears to argue that Doral‘s continued interest in the securities amounted to “practical ownership” of the securities by Doral, even in the face of
But in this case, the fact that Doral retained economic interests in the securities does not persuade us that Doral entrusted the securities to Lehman. To constitute entrustment, Doral‘s economic interests must somehow constrain Lehman to use the securities on Doral‘s behalf, so as to reflect “the indicia of [a] fiduciary relationship between a broker and his public customer.” Baroff, 497 F.2d at 284. But as explained above, the repos assigned title over the securities to Lehman, and that title carried with it the power to dispose of the securities as Lehman saw fit.5 Doral‘s continuing economic interests in the securities did not constrain Lehman‘s discretion over the securities, much less obligate Lehman to use those securities on Doral‘s behalf. Lehman‘s obligation to pass on principal and interest payments to Doral, for example, did not require Lehman to do anything with the securities; rather, the repos simply provided for Lehman to pay Doral an amount equal to the income generated by the securities. Similarly,
In sum, we hold that Lehman‘s unrestricted ownership of the securities defeats any suggestion that Doral entrusted the securities to Lehman when it entered into the repos. And because Doral did not entrust securities to Lehman, we further conclude that the appellant is not a customer for purposes of SIPA.6 With this conclusion in mind, we now turn to the appellant‘s other arguments: (1) that we should follow the “seminal” decision In re Bevill, Bresler & Schulman Asset Mgmt. Corp. (Cohen v. Army Moral Support Fund), 67 B.R. 557 (D.N.J. 1986)
C. In re Bevill, Bresler & Schulman Asset Mgmt. Corp.
The appellant relies heavily on the District of New Jersey‘s 1986 Bevill, Bresler decision, which held that certain repo participants were customers for purposes of SIPA. 67 B.R. at 598-602. Although a decades-old district court decision from another circuit would normally be of limited relevance, Bevill, Bresler has proven influential in subsequent courts’ analysis of this question. See, e.g., ESM, 812 F.2d at 1377 (discussing Bevill, Bresler). As such, the bankruptcy court, district court, and parties all devote substantial attention to Bevill, Bresler, seeking either to invoke or distinguish its holding. Accordingly, we address Bevill, Bresler separately here.
Bevill, Bresler arose out of the massive SIPA liquidation of the New Jersey broker-dealer Bevill, Bresler, & Schulman (“BBS“) in 1985. BBS entered into numerous repo and reverse repo transactions involving government and agency
The Bevill, Bresler district court found that the repo counterparties qualified as customers. The court began its analysis by concluding that repo counterparties fell within the facial definition of customer set forth in
Bevill, Bresler‘s analysis, however, conflicts with our holding in Baroff. At bottom, Bevill, Bresler never explains how repo participants satisfy Baroff‘s requirement that a customer must have “entrusted securities to a broker for some purpose connected with participation in the securities markets.” Baroff, 497 F.2d at 283. Nor does Bevill, Bresler explain how BBS‘s repo counterparties shared a relationship with BBS that had “the indicia of the fiduciary relationship between a broker and his public customer.” Id. at 284. Instead, Bevill, Bresler only uses the word “fiduciary” a single time, when explaining Baroff, and then never returns to the concept of a fiduciary relationship.
In short, although Bevill, Bresler acknowledges Baroff and our other entrustment precedents, the decision does not actually demonstrate how repo parties entrust assets to failed broker-dealers. Accordingly, we find Bevill, Bresler to be inconsistent with our caselaw, and decline to follow it here.
Finally, the appellant moves beyond entrustment, contending that Congress has settled the question of how repos should be treated under SIPA.
First, the appellant argues that by not specifically excluding repo participants from the customer definition, Congress implicitly confirmed that repos fall within the protection of SIPA. Congress specifically amended SIPA in 1978 to exclude certain types of securities lending, but never passed a similar exclusion for repos. See Securities Investor Protection Act Amendments of 1978, Pub. L. No. 95-283, § 15. Invoking the well-known canon of expressio unius est exclusio alterius—“the express mention of one excludes the other“—the appellant reasons that Congress must have intended not to exclude repos from SIPA.
This argument fails for exactly the reason stated by the district court: Doral has “failed to identify any basis to conclude that, in 1978, Congress was considering repurchase agreements, or that securities lending and repurchase agreements necessarily go hand in hand.” In re Lehman Bros. Inc., 506 B.R. at 357. “[E]xpressio unius . . . does not apply ‘unless it is fair to suppose that Congress considered the unnamed possibility and meant to say no to it.‘” Marx v. Gen. Revenue Corp., 133 S. Ct. 1166, 1175 (2013) (quoting Barnhart v. Peabody Coal Co., 537 U.S. 149, 168 (2003)).7
At the outset, we note that Congress enacted Dodd-Frank in 2010, after the SIPA liquidation of Lehman commenced in September 2008. Because customer status is determined as of the SIPA filing date, see In re New Times, 463 F.3d at 128, Dodd-Frank cannot make the appellant a customer. But more broadly, that Congress did not enact a specific provision is at best “marginal evidence” that it was rejecting the exclusion of repos from SIPA. Riverkeeper, Inc. v. U.S. EPA, 358 F.3d 174, 191 (2d Cir. 2004). This is especially true here, where, in light of Baroff and the Eleventh Circuit‘s decision in ESM, Congress may well have rejected the proposed amendment because it thought the amendment was superfluous in light of preexisting law. See Pension Ben. Guar. Corp. v. LTV Corp., 496 U.S. 633, 650 (1990) (“Congressional inaction lacks persuasive significance because several
Finally, the appellant points out that Dodd-Frank specifically excluded repos from the definition of customer in the portion of the Bankruptcy Code that governs the liquidation of stockbrokers. See
CONCLUSION
For the foregoing reasons, we conclude that the lower courts correctly determined that the appellant is not a customer for purposes of SIPA.
Accordingly, we AFFIRM the decisions below.