GREDE v. BANK OF NEW YORK MELLON

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v-first-bank#p1356908 F.2d 1351, 1356 (7 ^th Cir. 1990). There is no duty of "kindness" among non-fiduciaries. Id. at 1357. Merely enforcing the terms of a contract does not give rise to an equitable subordination claim. Id. Indeed, a non-fiduciary may act strategically to protect itself to the potential detriment of others. Badger Freightways v. Continental Ill. Nat. Bank, 106 B.R. 971, 976 (Bankr. N.D. Ill. 1989). Inequitable conduct for a non-fiduciary means "breach plus some advantage-taking," Kham Nate's, 908 F.2d at 1357, or else "gross misconduct tantamount to fraud, overreaching, or spoliation to the detriment of similarly situated claimants." Badger Freightways, 106 B.R. at 976. "Inequitable conduct is that conduct which may be lawful, yet shocks one's good conscience. It means, inter alia, a secret or open fraud, lack of faith or guardianship by a fiduciary; an unjust enrichment, not enrichment by bon chance, astuteness or business acumen, but enrichment through another's loss brought about by one's own unconscionable, unjust, unfair, close or double dealing or foul conduct." 80 Nassau Assocs. v. Crossland Fed. Savgs. Bank ( In re 80 Nassau Assocs.), 169 B.R. 832, 837 (Bankr. S.D.N.Y. 1994) (citing In re Tampa Chain Co., 53 B.R. 772, 779 (Bankr.S.D.N.Y. 1985)), quoting in turn In re Harvest Milling Co., 221 F. Supp. 836, 838 (D. Or. 1963). "[T]he few cases that actually subordinated an ordinary claim did so based upon a finding of actionable wrongdoing." In re Granite Partners, L.P., 210 B.R. at 515 (collecting cases).

The court cited: In re Bowman Hardware Elec. Co., 67 F.2d 792, 794-95 (7th Cir. 1933) (claimant who participated in scheme to misrepresent to another creditor the existence of the claimant's loan to the debtor was equitably subordinated to that creditor's claim); 604 Columbus Ave. Realty Trust v. Capitol Bank Trust Co., ( In re 604 Columbus Ave. Realty Trust), 119 B.R. 350, 377 (Bankr. D. Mass. 1990) (bank's claim would be equitably subordinated where bank was guilty of misappropriation of loan proceeds, fraud and breach of contract and its conduct caused injury to creditors and gave it an unfair advantage), aff'd in part and vacated in part on other grounds, 968 F.2d 1332 (1st Cir. 1992); Bank of New Richmond v. Production Credit Ass'n ( In re Osborne), 42 B.R. 988, 999-1000 (W.D. Wis. 1984) (claimant's misrepresentation to another creditor, coupled with that creditor's justifiable reliance, supported equitable subordination of claimant's claim but only to claim of injured creditor); see Boyajian v. DeFusco ( In re Giorgio), 862 F.2d 933, 939 (1st Cir. 1988).

In order to decide whether BNYM's claim should be subordinated, I consider (1) whether BNYM violated any duties; (2) whether BNYM's conduct shocks the conscience; and (3) whether BNYM'S misconduct conferred an unfair advantage or caused harm to creditors. Trustee maintains that BNYM has violated several duties, that its conduct is egregious, and that Sentinel's customers have been harmed. Significant to each argument is whether BNYM knew of Sentinel's misconduct.

First, Trustee maintains that BNYM not only knew of but actively participated in Sentinel's misappropriation of customer securities. In the alternative, Trustee maintains that BNYM was willfully blind, and should have known of Sentinel's misconduct. There is little dispute that negligence and breach of contract alone do not satisfy the equitable subordination standard. In Stratton, the court found that "knowledge of bookkeeping irregularities of a depositor or suspicions of a few employees of a large banking institution are not the equivalent of knowledge that another party doing business with the bank's depositor is being defrauded." Stratton, 104 B.R. at 731 (citation omitted).

BNYM contends that the extent of its duty was not to use funds maintained in the segregated accounts to offset any debt not incurred by Sentinel's customers. BNYM complied with the segregation requirements under the CEA and in the segregation letter, (discussed infra) and never liened on any securities in the segregated accounts. Moreover, even assuming that BNYM knew that Sentinel was violating its segregation requirements, BNYM was largely unaware of Sentinel's investment decisions, what Sentinel did with the loan, or how securities were allocated among clients and the house account. From BNYM's perspective, it was giving Sentinel a large loan of significant value that was being used for customers' benefit.

Trustee points out that BNYM had a contractual right to require Sentinel to "take any and all additional steps which [BNYM] requires[,]" to assure itself that Sentinel has the right to pledge customer-owned securities and had an unencumbered "first lien and security interest" in pledged securities, including notifying third parties or obtaining their consent. No one at the Bank took any action, e.g. speaking or emailing a customer, to confirm that Sentinel's customers knew that their assets were being pledged as collateral. But BNYM had no duty to Sentinel to take action, and in practice, it is difficult to see what BNYM's should have done under the circumstances. In closing, Trustee (implicitly recognizing the difficulty and impracticality of direct contact with Sentinel's clients) argued that BNYM employees should have at least asked Eric Bloom whether he had the authority to pledge the securities at issue or asked Bloom to produce customer agreements authorizing the pledge. But would such action have led to a different result? BNYM had a clearing agreement representing that Sentinel had the right to pledge the securities. The agreement was, in effect, Sentinel's position on the issue. BNYM had a ten-year relationship with Sentinel during which time it had no reason to believe that Sentinel was acting inappropriately.

Throughout the litigation, Trustee maintained that Bloom, allegedly engaged in misappropriation, was vague and misleading in his responses, and that as a result of Sentinel's misconduct, BNYM was not entitled to rely on Sentinel's representations and warranties. It is just too difficult to infer, in these circumstances, that had he been asked, Bloom would have said that he had no authority to pledge the assets. It is far more likely that Bloom would have maintained that he was legally allowed to rehypothecate customer securities — something he did, in fact, say during the April 10, 2006 conference call. Moreover, the no-action letter made clear that "[c]lient FCMs do not obtain a direct interest in any particular security or other investments maintained in the Seg I or Seg III Accounts. Client FCM's share in the profits and losses on the investments made by Sentinel on a pro-rata basis[.]" This would have made individual assurances from clients with regard to specific transfers of securities impracticable or impossible, since none of the securities within those accounts could be traced to individual investors. In addition, BNYM employees knew that Sentinel was regularly audited by outside firms and regulated by the NFA — facts from which BNYM employees did take comfort.

In Kham Nate's Shoes, the Seventh Circuit expressed its unwillingness to "to embrace a rule that requires participants in commercial transactions not only to keep their contracts but also do `more'-just how much more resting in the discretion of a [] judge assessing the situation years later." 908 F.2d at 1357. Here, BNYM was under no obligation to monitor Sentinel's transactions, and to do so would have been nearly impossible given the speed and number of transactions involved in investment management generally. BNYM exercised its contractual right to lien on the assets Sentinel placed in the collateral account. It is true that BNYM had in its possession several pieces of evidence which, especially in light of the totality of the circumstances, indicated misconduct. In fact, the circumstances raised such a suspicion in Rogers, but BNYM employees had little reason to believe that they could not rely on the representations and warranties contained in the contract that Sentinel had the authorization of its clients to pledge the securities at issue. Even though Law and Ciacciarelli possessed the forms 1-FR, they had no duty to study them for segregation violations (although BNYM's interests would certainly have been served by doing so), and no reason to do so, in light of the representations and warranties. BNYM may have been negligent, but the transactions were conducted at arm's length and in good faith. For these reasons, I find that BNYM's conduct does

not rise to the level of egregious and conscience-shocking, and its claim should not be subordinated.

Second, Trustee maintains that BNYM violated certain provisions of the CEA. Section 6d(a) requires FCMs to segregate customer assets. Trustee argues that FCMs are specifically permitted to invest commodity customer funds in securities and are required to segregate those securities even when they are not dealing in futures. As such, the segregation requirements of this section should apply. However BNYM disputes Sentinel's status as an FCM. Even though it was registered as one, it was not acting as one, and is therefore not subject to the segregation requirements of section 6d(a). Furthermore, BNYM argues, BNYM itself was not subject to the segregation requirements because Sentinel was not an FCM, and because there was no privity between Sentinel's FCM customers and BNYM.

Sentinel was never engaged in soliciting or accepting orders for the purchase or sale of any commodity for future delivery.

The evidence demonstrates that Sentinel considered itself subject to the CEA, and it reaped the benefits of being registered as an FCM. BNYM was aware of both of these facts. But not only was Sentinel subject to segregation requirements, BNYM was independently required to segregate pursuant to section 6d(b) of the CEA. That section provides:

It shall be unlawful for any person, including but not limited to . . . any depository, that has received any money, securities, or property for deposit in a separate account as provided in (Section 6d(a)(2)), to hold, dispose of, or use any such money, securities, or property as belonging to the depositing futures commission merchant or any other person other than the customers of such futures commission merchant.

7 U.S.C. § 6d(b) (emphasis added). According to Trustee, this section does not apply only to depositories receiving monies from FCMs, and to the extent that it does, Sentinel's Seg 1 clients — all of whom were FCMs — wired money directly to BNYM. Privity is not required in order for this section to apply. Even if BNYM's narrow interpretation is correct, Sentinel itself may be a "person" that received commodity customer funds from a "depositing futures commission merchant." In its amicus curiae memorandum, the CFTC agrees with the Trustee that (1) Sentinel should be treated as an FCM; (2) BNYM is independently required to segregate pursuant to section 6d(b); (3) no privity is required for duty to attach.

BNYM maintains in no way did it violate this provision of the CEA. It was not BNYM that ordered the desegregation of the accounts. In certain circumstances (e.g., where it was oversegregated), Sentinel was within its rights to transfer excess funds, and it would be impossible for a bank to determine whether an FCM was undersegregated. Sentinel warranted that it had the right to desegregate customers' securities and pledge them as collateral. Moreover, BNYM placed no liens on any of the segregated accounts.

BNYM suggests that Section 6d(b) simply prohibits it from liening on funds in segregated accounts. Trustee and CFTC read the statutory language as imposing a broader duty — once the funds meant to be segregated are deposited, they can only be used for the customer's own benefit. The CFTC explains:

At a minimum, it prohibits a depository bank from `holding' or `disposing of' commodity customer funds in a fashion that facilitates or, a fortiori, actively helps an account-holder's misuse of such funds. The language of section 6d(b) also specifies that the depository's duty with respect to the handling of segregated commodity customer funds applies to the `money, securities, or property' received for deposit in a segregated account. 7 U.S.C. § 6d(b). Thus, the fact that commodity customer funds may have been transferred out of a segregated account does not, by itself, discharge the depository's duty not to `hold, dispose of, or use' the funds as belonging to someone other than the underlying customers.

Neither Trustee nor CFTC cite authority in support of this position.

The Trustee and CFTC do suggest that BNYM may be liable for aiding and abetting Sentinel's breach of the CEA. In support, the CFTC cites a 1979 interpretative letter which states as follows:

[I]f a bank, with prior notice, permits or acquiesces in the withdraw[al] of customers' funds by a futures commission merchant for an unlawful purpose, the bank would violate or be aiding and abetting a violation of the [Commodity Exchange] Act. Although the scope of the bank's responsibility in circumstances of less than actual notice appears less clear, we believe it is certainly no less than when dealing with other trust accounts.

CFTC Interpretative Letter No. 79-1 (Responsibilities of Banks as Depositories of Customers' Segregated Funds), Comm. Fut. L. Rpt. (CCH) 20,835 (May 29, 1979). But the CFTC fails to cite the preceding sentence which states: "There is no case law discussing whether a bank has authority to assure that customers' funds are not misappropriated by futures commission merchants." Id.

Because BNYM violated no duty under the CEA, its conduct does not warrant the subordination of its claim.

Third, Trustee maintains that regardless of whether the CEA actually governed, BNYM agreed to segregate Sentinel's customer assets as part of the 1997 letter agreements. Trustee maintains that these letters remained in effect even after the accounts were transferred from the bank's Institutional Custody Division to the Broker/Dealer Services Division. In its supplemental amicus curiae memorandum, the CFTC supports Trustee's position that by signing the letters, BNYM was bound by the requirements of section 6d(b). In fact, had BNYM refused to sign the letters, BNYM could not have served as Sentinel's depository bank. As recently as 2004, the CFTC confirmed that one necessary condition to allow Sentinel to do business as a money manager for other FCMs was the existence of the letters outlining BNYM's agreement to segregate funds pursuant to the CEA. The evidence presented at trial demonstrates that Sentinel was subject to the CEA, and that the segregation letters were in fact binding agreements. But even if they were binding agreements, BNYM did not violate them, and their claim against Sentinel's estate should not be subordinated.

In March 1997, BNYM established segregated cash and securities accounts for Segs 1, 2, and 3 in its Institutional Custody Division. BNYM signed letter agreements for each of Sentinel's Seg pools, in which it agreed that Sentinel was an FCM subject to the CEA, that the assets in those accounts belonged to customers and would be segregated, and that BNYM could not assert a lien over those assets (the "Seg Letter Agreements"):
We propose to maintain accounts with yourselves, which shall be designated as "Sentinel Management Group, Inc. Customer Segregated Funds. . . . In this account we, as futures commission merchants, under the Commodity Exchange Act, shall deposit money, investment securities, and customer-owned securities. Such funds are money and securities deposited by or accruing to our customers which are commodity customers. In addition, all investments shall be made in accordance with the Commodity Exchange Act.

These accounts are being opened to meet the provisions of the Commodity Exchange Act. This statute provides that such money [be] segregated and treated as belonging to our customers rather than as belonging to ourselves. In carrying these accounts, you agree that the funds in said accounts will not be subject to your lien or offset for, and on account of, any indebtedness now or hereafter owing us to you. . . . Furthermore, you agree that this letter shall supersede any other documents related to this account that conflict with the terms of this Letter.

Fourth, Trustee asserts that under the IAA, BNYM "had both a direct obligation" and "an obligation not to subvert the IAA segregation requirement." A plain reading of the relevant section suggests that only investment advisors and not depositories have duties under the IAA. That section reads:

If you are an investment adviser registered or required to be registered under section 203 of the Act ( 15 U.S.C. 80b-3), it is a fraudulent, deceptive, or manipulative act, practice or course of business within the meaning of section 206(4) of the Act ( 15 U.S.C. 80b-6(4)) for you to have custody of client funds or securities unless [the finds are maintained by a qualified custodian in segregated accounts].

17 C.F.R. § 275.206(4)-2(a) (emphasis added). Trustee derives BNYM's duty from a parenthetical reference in a footnote of a 2009 notice of proposed rulemaking. Custody of Fund or Securities of Clients by Investment Advisers, 2009 SEC LEXIS 1645, at 5 n. 4 (May 20, 2009). There, the SEC suggests that the requirement that funds be maintained with a qualified custodian protects customers because such "institutions' custodial activities are subject to extensive regulation and oversight." In the relevant footnote, the SEC notes that banks have adequate systems in place to monitor risk in custody services areas and ensure segregation of customer accounts. While this note lays out important justification for the requirement of a qualified custodian, I do not see how the IAA directly imposes a duty on BNYM. BNYM's claim cannot be subordinated on this basis.

Fifth, Trustee contends that pursuant to industry practice, BNYM had custodial obligations where special deposits are involved. But only segregated accounts arguably qualify as special deposits, not the clearing accounts which were lienable. Therefore, even assuming that banks are "absolutely prohibited from asserting a lien over assets deposited in a special purpose account," BNYM did not violate that prohibition because it at no time liened on assets in the segregated accounts.

Sixth, Trustee asserts that BNYM was on notice of facts indicating a diversion of customer assets and had a duty to investigate. In Lerner v. Fleet Bank, N.A., 459 F.3d 273, 287-88 (2d Cir. 2006), the Court held that a bank which has actual or constructive knowledge of the diversion of customer assets "may be liable for participation in [such a] diversion, either by itself acquiring a benefit, or by notice or knowledge that a diversion is intended or being executed." The Court explained that "[a]s a general matter, a depositary bank has no duty to monitor fiduciary accounts maintained at its branches in order to safeguard funds in those accounts from fiduciary misappropriation. The bank has the right to presume that the fiduciary will apply the funds to their proper purposes under the trust." Id. at 287 (citations and quotations omitted). However, "a bank may be liable for participation in [such a] diversion, either by itself acquiring a benefit, or by notice or knowledge that a diversion is intended or being executed." Id. (quoting In re Knox, 477 N.E.2d 448, 451 (N.Y. 1985). Id. "Having such knowledge, [the bank is] under the duty to make reasonable inquiry and endeavor to prevent a diversion." Id. (emphasis added); accord Matter of Knox, 64 N.Y.2d 434, 438 (1985); Diamore Realty Corp. v. Stern, 855 N.Y.S.2d 206, 207-08 (App. Div. 2008); Home Sav. of Am., FSB v. Amoros, 661 N.Y.S.2d 635, 639-41 (App. Div. 1997). According to Trustee, BNYM's knowledge that (1) it was lending Sentinel hundreds of times in excess of its net capital on a nightly basis; (2) it was accepting as collateral securities that were to be segregated; (3) massive amounts of securities were transferred out of segregation and never back in; and (4) Sentinel was making misrepresentations to customers and regulators, was enough to trigger a duty to investigate.

BNYM maintains that Lerner does not apply here because a duty exists only if the "sole inference" from a customer's action is that it is misappropriating customer funds. Moreover, Lerner involves a negligent failure to detect misappropriation, which Sentinel admits is insufficient for equitable subordination. In its defense, BNYM further argues that (1) Sentinel agreed that it was acting lawfully and with authority; (2) BNYM did not know how Sentinel used the loan proceeds; (3) Sentinel made general disclosures that it might use some leverage in some manner; and (4) no other regulatory bodies caught the fraud.

BNYM's actions or inaction cannot support equitable insubordination unless it is egregious or conscience shocking. Negligence, which is the most that can be said of the conduct at issue, does not satisfy the requirements of equitable subordination.

C. The Harm to Sentinel

In making my finding in this case, I have considered what damages were caused by the conduct of the Bank. I do this partly to weigh the equities involved in subordinating the entire lien the Bank holds. Trustee asks in equity for a subordination of the entirety of a lien, which I do not find to be an equitable result. In the course of reaching this conclusion I made a calculation of the amount of the lien that should be subordinated if Trustee prevailed, and I find it prudent to include the calculation in this order. It is, of course, possible that a reviewing court may conclude that BNYM should be held liable. In the event it does so, the existence of a damage calculation might, under certain circumstances, speed disposition of the case as a whole without the necessity for a hearing on remand.

Trustee argues that BNYM's conduct conferred an unfair advantage on the Bank as well as caused harm to creditors. While it is true that the BNYM liens placed assets out of creditors' reach, BNYM did provide significant (if not full) value in exchange. It received relatively little advantage in such an exchange. BNYM benefited from the interest it received in association with the loan, which totaled nearly $4 million during the summer of 2007. This benefit is almost negligible to an institution of BNYM's size, and relative to the risk of the loan, even in light of the facts of which BNYM employees were aware.

I assume arguendo that beginning on June 26, BNYM's use of customer assets to pay down the loan further damaged creditors. In response, BNYM notes that it was fully secured at the time, and there was no harm to creditors. Had Sentinel gone into bankruptcy at the end of June, BNYM would have been fully secured and would have recovered the full loan balance. And finally, according to Trustee, Sentinel's July 31 transfer from the Seg 3 account to the lienable clearing account injured Seg 3 customers. But just before the transfer, Sentinel had segregated $512 million in the Seg I account. Because the liquidation plan in this case contemplates pro rata distribution, the Seg 3 customers will benefit just as much as the Seg 1 customers.

Trustee claims that creditors were also harmed when BNYM continued to lend to Sentinel after June 29, 2007. Had BNYM refused to lend to Sentinel, Sentinel would have been forced to liquidate, and creditors would have been spared further losses attributable to the diminution in value of certain securities. BNYM notes that this "deepening insolvency" theory of damages has been disfavored by some courts. As the Seventh Circuit noted in Fehribach v. Ernst Young LLP, the theory makes little sense "to fix liability on a third party for lending or otherwise investing in a firm and as a result keeping it going, when `management . . . misused the opportunity created by that investment. . . . [T]hey [management] could have instead used that opportunity to turn the company around and transform it into a profitable business. They did not, and therein lies the harm to [the company].'" 493 F.3d 905, 908-09 (7th Cir. 2007) (citing and quoting Seitz v. Detweiler, Hershey and Assoc., (In re CitX Corp.), 448 F.3d 672, 678 (3d Cir. 2006)). But these cases do not involve claims for equitable subordination, or the kind of misconduct alleged here, and were not intended to so apply.

In this case, it is true that BNYM gave Sentinel cash for the securities and it was Sentinel insiders who used the cash for their own purposes. BNYM had no hand in determining how Sentinel used the loan proceeds. The direct cause of the harm to creditors came from Sentinel. But BNYM can, in an uncommon sense, be considered the proximate cause for the reason that had Sentinel insiders been unable to use the securities as collateral, Sentinel would not have received the loan.

BNYM's expert at trial testified that the delay in liquidating the securities caused little additional harm to Sentinel's customers, and that any damages in this case are deminimis at best. Trustee's expert, Feltman, presented two methods to measure harm to creditors. The first is simply that customers were damaged in the amount of BNYM's final lien ($312 million plus interest), and that subordination of BNYM's entire claim is appropriate, but I disagree. BNYM was not the sole cause of harm to creditors. It was Sentinel that took the cash and used it for its own relatively risky purposes. BNYM had no hand in how the loan proceeds were used. In addition, the parties who stand to benefit from any subordination are sophisticated investors such as FCMs and hedge funds, who had substantial sums at stake. In fact, Discus Fund had invested more than $500 million by the end of 2006. These parties had signed agreements that disclosed that Sentinel might employ a leveraged investment strategy. Many of them had requested and received audited financial statements, and BNYM's expert Professor Cornell testified that any sophisticated investor could have deduced in less than thirty minutes that Sentinel was employing a leveraged strategy. These investors did little diligence.

Trustee's second method, the liquidation shortfall method, is more appropriate to determine damages here. This method attempts to measure the incremental harm to customers between various knowledge dates (dates by which BNYM, one hypothesizes, was on actual or constructive notice of the misuse of customer securities, should have declared a default and begun liquidation, selling enough collateral to pay down the loan and returning any excess to Sentinel) and various trigger dates (dates when the Trustee would have been able to begin liquidating the portfolio).

The analysis conducted by Feltman, however, appears to be flawed in that it compares hypothetical prices on the knowledge date against the value of the actual portfolio on the trigger date — a portfolio which, by the time of the trigger dates, was substantially liquidated at actual, not hypothetical prices. Citadel had purchased $370 million of securities at a price that was 10.2% off the market price. By then, repo counterparties had already liquidated their collateral at prices which yielded little equity for Sentinel, again deviating from hypothetical market prices. Such a comparison yielded a range of harm to customers from $323 million to $364 million depending on the knowledge and trigger dates used in the analysis.

The two trigger dates chosen — October 18, 2007, and December 14, 2007 — are the date of the first turnover of assets to Trustee and the date the bankruptcy court entered an order permitting the Trustee to begin selling property of the estate, respectively.

BNYM's expert, Professor Cornell, conducted the same analysis using the same knowledge dates, but trigger dates that were 15 weeks from the knowledge date, to account for the time it would take for a court-appointed fiduciary to obtain authority to liquidate the portfolio. This analysis used a 10.2% discount (just as in the sale to Citadel), and the trigger date preceded the sale to Citadel and the liquidation by repo counterparties. The calculations demonstrate no damages. Cornell applied the discount because the same discount was actually applied in the sale to Citadel, but Trustee takes issue with its, claiming that the Citadel transaction "was not an arm's-length transaction conducted by trustee, but was a coerced fire-sale conducted by a crook who acceded to pressure by regulators in a vain attempt to curry favor and hide his wrongdoing." For this reason, Trustee maintains that no discount should apply, or, any discount should be limited to 3%, resulting in the subordination of $240 million. But this figure appears to be arbitrary, and Trustee presents no support for the use of a 3% discount.

These calculations present a significant question: what discount should apply and why? There is little evidence in the record that answers this question. For this reason, I am persuaded to calculate harm using yet another model created by Cornell, where he calculated the liquidation value and shortfall using hypothetical model prices on three dates: May 31, 2007 (a knowledge date used by Feltman), June 29, 2007 (a knowledge date used by Feltman), and August 14, 2007 (the date BNYM called the loan). The range of harm using this method ranges from $37,543,407 to $61,592,452.

I am assuming for the purposes of calculating harm that some discount would have had to apply when liquidating a portfolio as large as Sentinel's in a relatively short time frame and given that the time market conditions were in flux and the subprime mortgage crisis was well under way.

The calculations demonstrate that the difference in shortfall between a May 31, 2007 liquidation, a June 29, 2007 liquidation, and an August 14, 2007 liquidation. The value of Sentinel's portfolio on August 14, the day BNYM called the loan, was $61,592,452 less than it was on May 31. Assuming, as Trustee argues, that by June 1, 2007, BNYM employees should have known that Sentinel was misappropriating customer securities, this is the calculation that would apply had BNYM stopped lending on May 31, the value of the securities that day would have been approximately $62 million more than the value on August 14, when the Bank called the loan. This was the harm the Bank caused by continuing to lend, as well as the $4,699,796.67 in interest it secured for itself that summer. If I assume that BNYM should have known of Sentinel's fraud by June 1 and should be held liable for its failure to call the loan, the $66,292,248.67 of the Bank's claim should be subordinated.

By June 13, Rogers had expressed his suspicion that the collateral was not Sentinel's to pledge, despite not having seen the 1-FRs to which Law and Ciacciarelli had access. Trustee argues in the alternative that at that point, BNYM employees should have taken a closer look at the 1-FRs and noticed the reported segregation violations. According to Trustee, on June 29, when BNYM was taking a closer look at the collateral it was holding and deciding whether or not to accept as collateral the physical securities posted by Sentinel, it should have been in a position to understand the extent of Sentinel's misconduct. The value of Sentinel's portfolio on June 29, was $37,543,407 less than it was on August 14, and during this period, BNYM secured for itself $2,894,507.80 in interest. Assuming that BNYM employees should have known of Sentinel's fraud by June 29 and should be held liable for its failure to call the loan by that date, $40,437,914.80 of BNYM's claim should be subordinated.

IV. CONCLUSIONS OF LAW

1. This Court has jurisdiction under 28 U.S.C. § 1334(b).

2. The June 1, June 26, June 29, July 17 and July 31 transfers were not fraudulent and cannot be avoided.

3. The June 29 and July 31 transfers were not preferential and cannot be avoided.

4. BNYM's lien on Sentinel's estate issue is valid and not subject to equitable subordination.

V. COUNTERCLAIMS

Defendants filed a counterclaim seeking declaratory judgment that Defendants have a valid, first-priority, perfected security interest in the lien that is the subject of the litigation. Defendants also allege breach of contract (based on the falseness of Sentinel's representations and warranties), request indemnification for attorneys' fees and expenses, and, if liable to Trustee, request a setoff of any damages due to the Bank as a result of Sentinel's alleged breach of contract and indemnification of fees and expenses. The total amount of Sentinel's outstanding indebtedness to BNYM is $312,247,000.00.

On June 27, 2009, Trustee answered the claims, but there has been no briefing since then and they were not addressed in the post-trial briefs. Almost all of the counterclaims, except for indemnification, are the converse of the Trustee's claims. However, I am severing the counterclaims and decline to rule on indemnification at this time as it is my intent to enter my findings in this order as final pursuant to Federal Rule of Civil Procedure 54(b). This appears to reflect the will of the parties as demonstrated by the fact that aside from the counterclaims themselves and an answer to those claims, there has been no other filing on these claims or any arguments directed to them. I conclude that BNYM has essentially put its counterclaims on hold, pending the outcome of the trial.

DATE: November 3, 2010