Prime Brokers May Be Liable for Customers Fraudulent Transfer
By: Michael Maffei
St. John's Law Student
American Bankruptcy Institute Law Review Staff
In a good news, bad news decision for prime brokers, the District Court in In re Manhattan Investment Fund v. Gredd
held that a prime broker is an initial transferee of funds held in a customer’s margin account, but recognized a “robust” good faith defense to transferee liability. In this appeal from an award of summary judgment,
[2]
Bear Sterns had receive approximately $141 million to cover margin calls for a hedge fund that, in reality, was a “Ponzi” scheme. In a holding that spells trouble for prime brokers, the Court rejected the argument that a prime broker is a “mere conduit” and lacks “dominion and control” over the funds in a margin account. Applying the Second Circuit’s “nuanced” approach, the Court rejects the narrow view that a party must have unfettered control over funds in order to be an initial transferee.
[3]
Since Bear Sterns could use the margin funds to protect itself against possible losses, it did not qualify as a mere conduit. Further, the discretionary authority given it as prime broker to close out positions, which was standard in the industry, was sufficient “control” to trigger transferee status.