The Bank of New York Mellon Corporation (formerly Bank of New York) was absolved of having engaged in “egregious misconduct” in connection with its relationship with Sentinel Management Group by a United States federal court in Chicago.
Sentinel was an investment management firm registered with the Commodity Futures Trading Commission as a futures commission merchant that claimed it specialized in short-term cash management for hedge funds, individuals, financial institutions and FCMs. The firm filed for bankruptcy in August 2007 after it unlawfully commingled US $460 million of client securities into its house account, and used client collateral to obtain a US $321 million line of credit. Eric Bloom, Sentinel’s former chief executive officer, was convicted earlier this year of defrauding Sentinel’s customers and awaits sentencing.
In August 2013, a US federal appellate court in Chicago had ruled that another proceeding must take place at the lower-level court to determine whether BNY Mellon appropriately protected itself by asserting a lien on assets of Sentinel in connection with a loan it granted the firm. Alternatively, the appellate court sought a determination of whether BNY Mellon was aware that Sentinel was using protected customer assets inappropriately to secure its lien; in which case it must return US $312 million, the value of collateral it held.
In its current decision, the court held that BNY Mellon’s conduct was not sufficiently wrongful to defeat its lien against Sentinel, and that its loan against collateral was made in good faith and should not be avoided. The liquidation trustee of the Sentinel liquidation trust has repeatedly argued that BNY Mellon was obligated to return the collateral to the trust.
Although the court acknowledged evidence that BNY Mellon was aware that Sentinel “was using at least some of the loan proceeds” backed by mixed customer and house collateral “for its own purposes,” the bank believed in good faith that such practice was legitimate, said the court. According to the court, Mr. Bloom, “a Sentinel insider, told [BNY Mellon] that Sentinel had permission, generally, to use client’s segregated funds as collateral for leveraged trading.” The reliance on Mr. Bloom’s representation was reasonable, claimed the court:
Long term stable banking relationships can give rise to actions based, in some part, on trust. That BNYM did not take further steps to investigate Sentinel’s practices for misconduct and, instead, relied on Sentinel’s statements is reasonable in the specific setting of this case. Good faith reliance is an inescapable requisite of a banking finance enterprise. BNYM is neither a father’s keeper nor a partner (despite the current advertising of some banks) of those companies to whom it loans money for business operations. A bank loan is an arm’s length deal. It is both legally and economically wrong to require of a bank the kind of systemic oversight that a parent or holding company often chooses to exercise over a subsidiary. Banks can exercise oversight if they choose, but that oversight is to ensure that the bank’s interest, and not the interest of the debtor, is protected. Close surveillance of the integrity of the debtor and its conduct might be better for a bank, particularly at the outset of the relationship, but this is not an iron-clad duty a bank owes to its debtor or to the debtor’s clients.
In holding for BNY Mellon, the court noted that the National Futures Association had audited Sentinel annually up to 2006, and that McGladrey LLP and its predecessor firm had routinely issued unqualified audit opinions regarding Sentinel’s statement of financial position. Relying on these reviews and the lack of other notice, BNY Mellon was justified in thinking nothing was askew, claimed the court:
There is no evidence in the record that either the auditor or regulator—independent entities with the power of oversight over Sentinel—knew or should have known of wrongdoing before Sentinel’s collapse. BNYM management could fairly rest on the protection of the collateral for its loan at least until such time as the NFA or auditors or, in this case, an inability to honor requests for customer redemptions started the bells ringing. BNYM, I concluded, neither knew nor should have known that Sentinel was misusing loan proceeds or participating in any other misconduct.