Frederick J. Grede, not individually but as Liquidation Trustee of the Sentinel Liquidation Trust, Plaintiff-Appellant / Cross-Appellee,
FCStone, LLC, Defendant-Appellee / Cross-Appellant.
June 7, 2017
from the United States District Court for the Northern
District of Illinois, Eastern Division. No. 09 C136 - James
B. Zagel, Judge.
Ripple, Rovner, and Hamilton, Circuit Judges.
Hamilton, Circuit Judge.
2007 bankruptcy of Sentinel Management Group, Inc. has echoed
through the courts for ten years now. This is our fifth
appeal dealing with Sentinel. In a pair of cases decided in
2013 and 2016, we addressed the priority of a claim against
the bankruptcy estate by the Bank of New York, Sentinel's
largest (but no longer secured) creditor. In re Sentinel
Management Group, Inc., 728 F.3d 660 (7th Cir. 2013);
Grede v. Bank of New York Mellon Corp. (In re Sentinel
Management Group, Inc.), 809 F.3d 958 (7th Cir. 2016).
Earlier this year, we affirmed the convictions and sentence
of Sentinel's former president and CEO, who was
prosecuted for wire fraud and investment adviser fraud.
United States v. Bloom, 846 F.3d 243 (7th Cir.
Grede v. FCStone, LLC, 746 F.3d 244 (7th Cir. 2014)
(FCStone I), the direct predecessor to this appeal,
we considered among other issues a distribution of $297
million to a group of Sentinel customers a few days after
Sentinel filed for bankruptcy protection in August 2007.
Following a bench trial, the district court had allowed the
trustee in bankruptcy to avoid this post-petition transfer
under 11 U.S.C. § 549. We reversed, holding that relief
under § 549 was unavailable to the trustee because the
bankruptcy court had authorized the transfer. We rejected the
trustee's reliance on an October 2008
"clarification" through which the bankruptcy judge
indicated that he had not intended to foreclose a § 549
avoidance action. Later statements by the judge about his
subjective intentions could not, we concluded, defeat the
plain language of the order authorizing the transfer. We
remanded for further proceedings, which led to these new
our holding in FCStone I that "the bankruptcy
court authorized the post-petition transfer" and that
the trustee "therefore cannot avoid the transfer, "
746 F.3d at 258, the trustee argued on remand that the
bankruptcy judge's October 2008 "clarification"
was entitled to preclusive effect. Since FCStone did not
appeal that "clarification" when it was made, the
trustee argued, FCStone should be bound by it and
collaterally estopped from arguing that the post-petition
transfer was authorized. The district court rejected the
trustee's argument on this point, and we affirm on two
independent grounds. First, pursuant to the mandate rule and
the law-of-the-case doctrine, the collateral estoppel theory
was unavailable to the trustee on remand. Second, even if the
theory were available despite our unambiguous holding in
FCStone I, the bankruptcy judge's
"clarification" was not the sort of final ruling
that could be entitled to preclusive effect.
cross-appeal, FCStone raises an issue that lingered in the
background but was not squarely presented during the previous
appeal. The question concerns the proper distribution of
nearly $25 million held in reserve under the confirmed
bankruptcy plan. FCStone argues that these funds are trust
property belonging to it and other creditors in its customer
class who are protected by statutory trusts under the
Commodity Exchange Act. The district court disagreed,
treating the funds instead as property of the bankruptcy
estate subject to pro rata distribution among all Sentinel
customers and other unsecured creditors. On this
cross-appeal, we reverse. Under the Bankruptcy Code, property
held by the debtor in trust for others is by definition not
property of the bankruptcy estate. Pursuant to the confirmed
bankruptcy plan, FCStone and similarly situated customers
preserved their right to recover their trust property. These
creditors are entitled to the benefit of reasonable tracing
conventions. Moreover, FCStone introduced essentially
unrebutted evidence at trial showing that it can trace a
portion of the reserve funds back to its investment. FCStone
is entitled to recover its proportionate share of the reserve
funds. The reserve funds should be distributed pro rata among
FCStone and other members of its customer class.
Factual Overview and Procedural History
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.
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.
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.
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
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.
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.
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 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.
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.
Chapter 11 Proceedings
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
received $297 million in what the parties describe as the
"post-petition transfer/' with FCStone receiving a
little shy of $15 million.
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.
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
prior order. The judge said, however, that he was clarifying
the order in that he "did not decide on August 20 and
... am not deciding today whether or not any of the proceeds
that were the subject of that order are property of the
estate ... or whether ... they were trust funds." The
judge said that in his August 20 order, he "did not
intend to foreclose the trustee or any party from any
avoidance action whatsoever."
bankruptcy court entered an order confirming the Fourth
Amended Chapter 11 Plan of Liquidation in late 2008. (We
discuss several provisions of the confirmed Chapter 11 plan
in Part II-B.) Around that same time, the trustee commenced
adversary actions against FCStone and other SEG 1 customers
who had received distributions from the Citadel security sale
back in August 2007. The trustee sought to avoid the
post-petition transfers and to recover the Citadel sale
proceeds (Count I), and he requested a declaration that funds
held in reserve are property of the bankruptcy estate (Count
III). The district court withdrew the reference
to the bankruptcy court, see 28 U.S.C. § 157(d), and
presided over the case against FCStone as a test case.
a bench trial, the district court ruled in favor of the
trustee on Counts I and III. Grede, 485 B.R. at
889-90. The court concluded that the Citadel sale proceeds
should be treated as property of the bankruptcy estate.
Id. at 880. The court reasoned that (1) both SEG 1
and SEG 3 customers were protected by statutory trusts; (2)
because the two classes of customers were similarly situated
and because there were insufficient funds to satisfy all
their claims, tracing fictions or conventions were
inappropriate; and (3) FCStone and other SEG 1 customers
could not trace the Citadel sale proceeds back to their
original investments given Sentinel's coming-ling and
misappropriation of customer assets that should have been
segregated in trust for the customers. Id. at 873,
878, 880. The district court added that, for purposes of 11
U.S.C. § 549, and in light of the bankruptcy court's
2008 "clarification, " the 2007 post-petition
transfer had not been "authorized" by the
bankruptcy court. Id. at 881.
reversed in FCStone I, 746 F.3d at 260. We explained
that the bankruptcy court's after-the-fact
"clarification" of its subjective intentions
concerning the post-petition authorization order ran contrary
to the plain language of the order and amounted to an abuse
of discretion. Id. at 255. "Whether the
property belonged to the estate or not/' we reasoned,
"in the absence of reversal, the authorization order
ended any discussion about its original ownership, and the
disputed property cannot later be clawed back by the
the parties had focused on the post-petition transfer, we did
not specifically address the status of the funds held in
reserve. For that matter, we declined to decide
"whether the funds at issue were, in fact, property of
the estate, " id. at 258, though we agreed with
the district court that there was no generally applicable
legal basis for placing one statutory trust ahead of another.
We tentatively approved the district court's requirement
that would-be trust claimants (such as FCStone) must actually
trace their investment property to the disputed funds.
Id. at 259. We remanded for further proceedings.
The Decisions on Remand
remand, the trustee moved for judgment on Counts I and III,
while FCStone sought judgment on Count I and summary judgment
on Count III. With respect to Count I, the trustee argued
that FCStone should be collaterally estopped from asserting
that the post-petition transfer was authorized. In the
trustee's view, the bankruptcy judge's October 2008
"clarification" was entitled to preclusive effect.
The district judge disagreed, writing that our decision in
FCStone I-holding that the "clarification"
was an abuse of discretion-stripped that ruling of "any
force and effect." Grede v. FC Stone, LLC, 556
B.R. 357, 362 (N.D. Ill. 2016). The court entered judgment
for FCStone on Count I. The trustee appeals that decision.
district judge then considered the status of the disputed
reserves. The judge reiterated his view that equity prevented
him from "favoring one statutory trust claim over
another" and that actual tracing is difficult if not
impossible given Sentinel's egregious pattern of
commingling. Id. at 365. The judge concluded that
the reserve funds should be treated as property of the
estate, subject to pro rata distribution according to the
confirmed Chapter 11 plan. Id. at 366. The court
entered judgment for the trustee on Count III. FCStone
cross-appeals that decision.
The Trustee's Appeal - Collateral Estoppel
issue of collateral estoppel (also known as issue preclusion)
presented by the trustee's appeal, no facts are disputed,
so we review de novo the district court's
decision on this question of law. Adams v. Adams,
738 F.3d 861, 864 (7th Cir. 2013); Bernstein v.
Bankert, 733 F.3d 190, 225 (7th Cir. 2013).
Mandate Rule and Law of the Case
trustee's collateral estoppel argument is
straightforward, if improbable. In the trustee's view,
FCStone's failure to appeal the bankruptcy court's
oral "clarification" of its prior written order
means that FCStone should be bound by that
"clarification" rather than being able to rely on
the underlying order.
preliminary matter, we conclude that the collateral estoppel
argument was not even available to the trustee on remand
following our decision in FCStone I. We did not
specifically address collateral estoppel in our prior opinion
because the trustee did not raise the issue, even though he
had presented it earlier to the district court as an
alternative argument in support of his § 549 avoidance
action. But our broader discussion of the post-petition
transfer left nothing to the imagination on this point. We
said that the transfer was authorized and that it therefore
"cannot be avoided under the express terms of 11 U.S.C.
§ 549." FCStone I, 746 F.3d at 247. We
repeated that the transfer was "clearly authorized"
and that, regardless whether the transferred property was
part of the bankruptcy estate, "in the absence of
reversal, the authorization order ended any discussion about
its original ownership, and the disputed property cannot
later be clawed back by the trustee." Id. at
our unambiguous resolution of the dispute over the
post-petition transfer, two closely related doctrines-the
mandate rule and the law-of-the-case doctrine-should have
precluded the trustee from resurrecting his collateral
estoppel theory in the district court and getting a second
bite at the § 549 apple. Compare EEOC v. Sears,
Roebuck & Co.,417 F.3d 789, 796 (7th Cir. 2005)
("In general, any issue conclusively decided by this
Court on appeal may not be reconsidered by the district court
on remand."), and United States v. Polland, 56
F.3d 776, 777 (7th Cir. 1995) ("The mandate
rule requires a lower court to adhere to the commands of a
higher court on remand."), with United States v.
Adams,746 F.3d 734, 744 (7th Cir. 2014) ("The law
of the case doctrine is a corollary to the mandate rule and