Opinion ID: 4195554
Heading Depth: 1
Heading Rank: 1

Heading: Factual Overview and Procedural History

Text: We review the most salient facts of the case, drawing from the district court’s findings after the earlier bench trial. More complete discussions of Sentinel’s downfall and the criminal misconduct of senior executives are included in the district court’s earlier opinion, Grede v. FCStone, LLC, 485 B.R. 854, 859–67 (N.D. Ill. 2013), and in our opinions in Bloom, 846 F.3d at 246–50, and FCStone I, 746 F.3d at 247–51. In brief, Sentinel managed investments for futures commission merchants (FCMs) like FCStone, as well as for other classes of investors. FCMs act as financial intermediaries between investors and futures markets. They are regulated under the Commodity Exchange Act. Sentinel itself was an FCM and so was regulated under the Act. Sentinel organized its customers in different tranches known as segments or “SEGs.” Within each SEG, customers were further divided into investment groups based on their risk appetites and financial goals. As relevant to this appeal, FCM customer assets were held in SEG 1, with FCStone’s customer assets placed in Group 7. SEG 3 contained assets belonging to hedge funds and other sophisticated investors, as well as FCM proprietary or “house” funds. When customers invested funds with Sentinel, those funds were exchanged for securities and interest-bearing cash through a process that Sentinel called “allocation.” Customers did not own securities outright but instead held indirect pro rata interests in the securities allocated to their group portfolios, as determined by their level of investment. Nos. 16-1896 & 16-1916 5 Both the SEG 1 and SEG 3 customers were entitled to special protections under federal law. FCM customers who invested their own clients’ funds in SEG 1 were protected by the Commodity Exchange Act and regulations promulgated by the Commodity Futures Trading Commission (CFTC). SEG 1 and SEG 3 customers alike were protected by the Investment Advisers Act of 1940 and regulations promulgated by the Securities and Exchange Commission (SEC). Both regulatory regimes required Sentinel to hold customer funds in segregation, i.e., separate from funds belonging to other customer classes and separate from Sentinel’s own or “house” funds. Both regimes also created statutory trusts in the customers’ favor to protect their property from Sentinel and its other creditors. Sentinel, unfortunately, did not honor the statutory trusts and comply with the segregation rules under the Commodity Exchange Act and the Investment Advisers Act. Instead, as the district court found, Sentinel routinely used hundreds of millions of dollars in securities it had allocated to customers as collateral to support Sentinel’s own borrowing to pursue its leveraged trading strategy for its own benefit. It moved those securities out of segregation and into a lienable account at the Bank of New York, its main lender, putting customer property at risk for Sentinel’s benefit. As Sentinel’s leveraged trading increased, its outstanding debt ballooned, and it drew more and more on its customers’ assets to support its borrowing habit. During the summer of 2007, Sentinel’s investment scheme collapsed. As credit markets tightened and liquidity dried up on Wall Street (this was the beginning of what would become the financial crisis of the late 2000s), the market value of many 6 Nos. 16-1896 & 16-1916 Sentinel assets dropped. Sentinel’s trading partners began making demands that forced it to borrow more heavily and in turn to provide more collateral—which it did by using customers’ property as collateral. In late June and July 2007, Sentinel moved $250 million worth of securities allocated to SEG 1 to the lienable Bank of New York account. Then, in late July, Sentinel swapped these securities with securities allocated to SEG 3 customers, resulting in a “massive shift of loss exposure” from SEG 1 to SEG 3. See Grede, 485 B.R. at 866. That final manipulation proved fateful for SEG 3 customers in the looming bankruptcy. Sentinel’s wheeling and dealing had bought it some time, but in the end the firm could not keep up with redemption requests and demands from the Bank of New York. On Monday, August 13, 2007, Sentinel advised its customers that it was halting all redemptions (i.e., payments to them from their accounts). On Thursday, August 16, Sentinel sold a large portfolio of securities then allocated to SEG 1 to a firm called Citadel, depositing the proceeds in a SEG 1 cash account at the Bank of New York. The next day, Sentinel filed for Chapter 11 bankruptcy protection.

On Monday, August 20, 2007, the first business day after it filed for bankruptcy, Sentinel (still under the control of its insiders) filed an emergency motion in the bankruptcy court seeking an order approving payment of the Citadel sale proceeds to SEG 1 customers. After emergency hearings, the bankruptcy court issued an order authorizing the Bank of New York to disburse the funds, less an approximately five percent holdback. The bank did so, and the SEG 1 customers Nos. 16-1896 & 16-1916 7 received $297 million in what the parties describe as the “post-petition transfer,” with FCStone receiving a little shy of $15 million. Frederick Grede was appointed as Chapter 11 trustee. The bankruptcy court approved his appointment on August 29, 2007, within the fourteen-day window for appealing the order authorizing the post-petition transfer. See Fed. R. Bankr. P. 8002. The trustee did not appeal. A year later, however, he filed a “Motion to Clarify or in the Alternative to Vacate or Modify the Court’s August 20, 2007 Order.” In essence, the trustee argued that he should be permitted to bring avoidance actions against FCStone and the other SEG 1 customers who received, in the trustee’s view, a disproportionate payout through the post-petition transfer. A group of SEG 1 customers including FCStone opposed the trustee’s motion. At the conclusion of a hearing on the motion, the bankruptcy judge declined to vacate or modify the