August 27, 2013 / 12:08 AM / 5 years ago

Court reverses ruling on Sentinel loan in blow to BNY Mellon

CHICAGO (Reuters) - Bank of New York Mellon Corp (BK.N) may have to get in line behind former customers of Sentinel Management Group who are seeking to recoup money lost in the futures broker’s 2007 collapse, a U.S. appeals court ruled on Monday.

A BNY Mellon sign is seen on their headquarters in New York's financial district, January 19, 2011. REUTERS/Brendan McDermid

The U.S. Court of Appeals for the Seventh Circuit in Chicago reversed part of a ruling by U.S. District Judge James Zagel and said he must revisit the case. Zagel had previously put the bank ahead of Sentinel’s former clients.

If Zagel agrees with the appeals court’s decisions, the bank may have to return about $312 million to Sentinel’s bankruptcy trustee for distribution to former clients, according to a lawyer for trustee Frederick Grede.

Monday’s decision is a “big victory for the protection of customers and customer funds,” Grede said. Sentinel was based in a Chicago suburb.

Kevin Heine, a spokesman for Bank of New York Mellon, said the bank had no immediate comment.

Sentinel largely managed money for other futures brokers, delivering outsized returns that Grede said were boosted by improperly using customer money to secure loans that funded risky trades.

The scheme unraveled when the credit crisis began in the summer of 2007.

Grede alleged that the broker pledged hundreds of millions of dollars in customer assets to secure an overnight loan at Bank of New York Mellon, leaving the bank in a secured position but Sentinel’s customers with losses of millions.

Futures brokers are required to keep customers’ funds in dedicated accounts to protect them from being used for anything other than client business.

At Sentinel, customer funds were allegedly moved from the protected accounts to other accounts so they could be used as collateral for loans to Sentinel’s own trading operations.

Former customers of the firm have received back about 35 percent of the $600 million that was missing when Sentinel collapsed, said Chris Gair, a lawyer for the trustee. The appeals court’s decision shows that the requirement to keep customer funds segregated “really has teeth,” he said.

Since Sentinel’s collapse, the futures industry has been rattled by the bankruptcies of two more brokers: MF Global in 2011 and Peregrine Financial Group in 2012. The heads of both firms were alleged to have improperly used customer money.

The case is Frederick Grede v. Bank of New York Mellon Corp., in the U.S. Court of Appeals for the Seventh Circuit, no. 10-3787.

Editing by Lisa Shumaker

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