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Securities Compliance Sentinel Analysis of cutting-edge securities industry issues

The Sky May Actually Be Falling. . . Securities Clearing Firms May Be Liable for Fraudulent Transfers

Posted in Arbitration, Clearing Firms, Public Customer Arbitrations

The case below should be immediately filed in the “Uh Oh” category because the result indicates the potential for increased liability for securities clearing firms when a fraudulent transfer is alleged.

The United States Court of Appeals for the Second Circuit refused to vacate an arbitration award against a securities clearing firm where it had been alleged a fraudulent transfer occurred.  See Goldman Sachs Execution and Clearing LP v. Official Unsecured Creditors’ Comm. of Bayou Group, LLC, 2012 U.S. App. LEXIS 13531 (2nd Cir. July 3, 2012).  The Second Circuit found that the sole clearing broker and prime broker for a group of hedge funds affiliated with Bayou Fund LLC were required to arbitrate a matter involving fraudulent transfer claims, and that the FINRA arbitration proceeding, finding the clearing broker was the initial transferee of such transfer and not a mere conduit of the ultimate transfer, was valid.  As such, the FINRA arbitration panel awarding the clearing broker $20 million dollars would not be vacated.  In keeping with FINRA fashion, the arbitration panel did not issue a written decision.

Further, the Second Circuit based its conclusion that the FINRA arbitration panel had not manifestly disregarded the law on the Bear Stearns Securities Corp. v. Gredd, 391 BR.l (S.D.N.Y. 1997), case.  In the Gredd case, the Court found that Bear Stearns was liable as the initial transferee in a ponzi scheme customer where Bear Sterns had controlled the customer funds.  The Second Circuit believed that the current case and Gredd were very similar.

            In short, although the Second Circuit concluded this was not a novel approach, securities clearing firms should certainly prepare for the worst—given those firms now seem to have a target on their backs!!