# Matter of Bevill, Bresler & Schulman Asset

> District Court, D. New Jersey · October 23, 1986 · 67 B.R. 557

URL: https://www.frixlaw.com/law-library/cases/1543384

## Case

- **Court:** District Court, D. New Jersey
- **Decided:** October 23, 1986
- **Citations:** 67 B.R. 557
- **Precedential status:** Published
- **Opinion:** Opinion
- **Judges:** Debevoise
- **Cited by:** 25 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/1543384

## How later opinions describe it (automated extraction)

- holding that the intent of the parties to the transaction, as indicated by its structure as a purchase and sale, and not an evaluation of its economic content, controls its characterization in bankruptcy

## Opinion text

67 B.R. 557 (1986)
In the Matter of BEVILL, BRESLER & SCHULMAN ASSET MANAGEMENT CORPORATION, Debtor.
Saul S. COHEN, Trustee of Bevill, Bresler & Schulman Asset Management Corporation, Plaintiff,
v.
ARMY MORAL SUPPORT FUND: Bay Ridge Federal Savings & Loan; Broker's Capital; Bushnell Federal Savings & Loan; Champlain Valley Federal Savings & Loan; Chester Bank; Citizens Savings & Loan, Bellefontaine; Cross Country Federal Savings & Loan; Fidelity Savings & Loan, Berwyn, Illinois; First Federal Savings Bank; First Federal Savings & Loan, Freeport; First Federal Savings & Loan, Washington Court House; First National Bank of Elkhart; First National Bank of Skokie; First National Bank of Toms River; First Savings & Loan Association (Perth Amboy); Fort Lee Savings & Loan; Gibraltar Savings & Loan; Glen Ridge Savings & Loan; Government Employees Credit Union; Great American Federal Savings & Loan; Greenville Federal Savings & Loan; Harvest Home Savings & Loan; Hi-Plains Savings & Loan Association; Home Savings Association; Imperial Savings & Loan; Jefferson Building & Savings; Lesney Products Corp.; Lincoln Way Federal Savings & Loan; Mainland Savings & Loan; Mercer Savings & Loan Association; Merritt Commercial Savings & Loan; Midwest Government Securities; Niagara County Savings Bank; Newport National Bank of Providence; Old Borough Savings & Loan; Old Court Savings & Loan; Pennbank; Peoples Savings & Loan Assn.; Provident Savings & Loan; Prudential Federal Savings & Loan; Saranac Lake Federal Savings & Loan; Savers Bank; Savings Building & Loan; Security Savings & Loan; Seneca Federal Savings & Loan; Security Pacific Clearing & Services Corp.; Sentry Savings; Sewickley Savings & Loan Assn.; Southern Illinois Bank; United *558 Financial Savings Bank, F.S.B.; Universal Savings & Loan; Vernon Savings & Loan; Village Bank; First Federal Savings & Loan Assn. of Waterbury; General Trading Co., Inc.; Fidelity New York, F.A.; Wallkill Valley Federal Savings & Loan Assn.; First Federal Savings & Loan Assn. of Lincoln, Nebraska; Mutual Federal Savings & Loan Assn. of Sidney, Ohio; Morton Federal Savings & Loan; Odessa Savings Assn.; Calvert Insurance Company; Fairbanks Broadcasting Co., Inc.; Bradford Trust Company; Mona Williams; Westbury Savings & Loan; Worthen Bank & Trust Company, N.A.; Yonkers Savings Bank and Yorkridge Calvert Savings & Loan, Defendants.
In the Matter of BEVILL, BRESLER & SCHULMAN, INC., Debtor.
Richard W. HILL, Trustee for the Liquidation of Bevill, Bresler & Schulman, Inc., Plaintiff,
v.
FIDELITY NEW YORK, F.A., Champlain Valley Federal Savings & Loan Association; Worthen Bank & Trust Company, N.A.; Mainland Savings & Loan Association; City of Harrisburg, Pennsylvania; Maryland Savings-Share Insurance Corporation, as Conservator of Old Court Savings and Loan Inc.; and Security Pacific Clearing & Services Corporation, Defendants.
Civ. A. Nos. 85-1728, 85-2224, Adv. Nos. 85-2103, 85-5274.
United States District Court, D. New Jersey.
October 23, 1986.
*559 Ravin, Greenberg & Zackin by Jack M. Zackin, Gary N. Marks, Roseland, N.J., for Saul S. Cohen.
McCarter & English by Hayden Smith, Jr., Anne W. Crawford, John F. Brenner, Charles J. Benjamin, Newark, N.J., for Richard W. Hill.
Theodore H. Focht, Gen. Counsel, Securities Investor Protection Corp., by Michael E. Don, George F. Bingham, Washington, D.C.
Kirkpatrick & Lockhart by Joseph J. Brigati, Charles Lee Eisen, Douglas J. Scheidt, Washington, D.C., for Bayamon Federal Sav. & Loan Ass'n.
Rhoads & Sinon by Charles J. Ferry, Dean H. Dusinberre, Harrisburg, Pa., for City of Harrisburg, Pa.
Cowen, Liebowitz & Latman, P.C. by J. Christopher Jensen, New York City, for Federal Sav. & Loan Ins. Corp. as Receiver of Mainland Sav. Ass'n.
*560 Buckley, Kremer, O'Reilly, Pieper, Hoban & Marsh, Mineola, N.Y., for Fidelity N.Y., FSB.
Milbank, Tweed, Hadley & McCloy by Russell E. Brooks, Joseph S. Genova, Stephen J. Shimshak, New York City, for Huntington Sav. & Loan Ass'n.
Weil, Gotshal & Manges by Martin J. Bienenstock, Tonny K. Ho, Deryck A. Palmer, New York City, for Cuero Federal Sav. & Loan Ass'n.
William J. Scanlon Law Offices by Kathleen M. Scanlon, Fort Lee, N.J., for Fort Lee Sav. & Loan Ass'n.
Rose Law Firm, P.A. by Allen W. Bird, II, Michael R. Johns, Little Rock, Ark., and Scarpone & Edelson, P.C. by James A. Scarpone, Newark, N.J., for Worthen Bank & Trust Co. N.A.
Gaston, Snow, Beekman & Bogue by Catherine A. Ludden, New York City, for Sec. Pacific Clearing & Services Corp.
Wilkie, Farr & Gallagher by Roger D. Blanc, James J. Calder, William H. Rooney, New York City, for Prudential Federal Sav. & Loan Ass'n.
Kraft & Hughes by John B. Hall, Newark, N.J., and Ira Lee Sorkin, Regional Adm'r S.E.C. by Jason R. Gettinger, New York City.
Federal Reserve Bank of N.Y. by Mary Sue Sullivan, Andrew C. Harvard, New York City.
Cadwalader, Wickersham & Taft by Barry J. Dichter, H. Peter Haveles, Jr., Leslie R. Caldwell, Leonard J. Cali, New York City, for Official Committee of Reverse Repurchase Participants.
Carpenter, Bennett & Morrissey by Jerome E. Sharfman, Newark, N.J., and Okin, Pressler, Cohen & Hollander by Paul S. Hollander, Fort Lee, N.J., and Hahn & Hessen by Gilbert Backenroth, New York City, for Unofficial Committee of Repo Participants, Champlain Valley Federal Sav. & Loan Ass'n, First Federal Sav. & Loan Ass'n of Freeport, and Lesney Products Corp.
Hannoch Weisman by Ronald M. Sturtz, Arlene E. Mirsky, Roseland, N.J., for Official Creditors' Committee.
Clancy & Foster by Charles Clancy, East Orange, N.J., for Gibraltar Sav. & Loan Ass'n.
Gagliano, Tucci, Iadanza & Reisner by Ronald L. Reisner, West Long Branch, N.J., for East Jersey Sav. & Loan Ass'n.
Porter, Wright, Morris & Arthur by H. Grant Stephenson, Columbus, Ohio, for Connie J. Harris, Successor-in-Interest to Jefferson Bldg. & Sav. Co.
TABLE OF CONTENTS
I. INTRODUCTION
II. PROCEDURAL BACKGROUND
III. FACTUAL BACKGROUND
A. The Debtors
B. Repos and the Repo Market
C. The Test Cases
1. Overview
2. The AMC Test Case Transactions
a. GNMA Pool #69692
b. GNMA Pool #61337
c. U.S. Treasury Notes, 11.125%
d. GNMA Pool #40566
e. GNMA Pool #57318
3. The BBS, Inc. Test Case Transactions
a. GNMA Pool #47448
*561
b. GNMA Pool #63571
c. FHLB, Cusip #31388MX5
d. U.S. Treasury Bills, Cusip #912794HQ0
IV. ISSUES
V. DISCUSSION
A. Legal Characterization of Repo and Reverse Repo Transactions
1. Contentions of the Parties
2. Applicable Law
3. Express Terms of Repo and Reverse Repo Agreements
4. Extrinsic Evidence of Intent
a. Books and Records of the Parties
b. Accounting Conventions
c. Regulatory Treatment
d. Trade Custom and Usage
5. Decisional Law
a. Tax Cases
b. Securities Fraud Cases
c. Bankruptcy Cases
6. Conclusion
B. Customer Status under SIPA
C. Treatment of Reverse Repo Agreements
D. Delivery/Transfer of Securities to AMC Repo Participants
1. Section 8-313(1)(a) of the N.Y.U.C.C. and N.J.U.C.C.
2. N.J.U.C.C. § 12A:8-313(1)(e) and N.Y.U.C.C. § 8-313(1)(g)
3. N.J.U.C.C. § 12A:8-313(1)(d)
4. N.J.U.C.C. § 12A:8-313(1)(c) and N.Y.U.C.C. § 8-313(1)(d)
5. Conclusions as to Deliver/Transfer
a. Certificated and Book-Entry Securities in the AMC Clearing
Account
b. Certificated Securities in the AMC Safekeeping Account
c. Book-Entry Securities in the AMC Safekeeping Account
E. Imposition of Constructive Trusts over Securities in the AMC Clearing
Account
VI. CONCLUSIONS
GROSSARY OF ABBREVIATIONS
AMC - Bevill, Bresler & Schulman Asset Management Corporation
Bayamon - Bayamon Federal Savings & Loan Association of Puerto Rico
BBS, Inc. - Bevill, Bresler & Schulman, Inc.
Bradford - Bradford Trust Company
Champlain - Champlain Valley Federal Savings & Loan Association of Plattsburgh
Clearing Agreement - Clearing, Custody and Financing Agreement
The Code - The Bankruptcy Code, 11 U.S.C. § 101 , et seq.
Cuero - Cuero Federal Savings & Loan Association
*562
Dauphin - County of Dauphin, Pennsylvania
Dominion - Dominion Bank, N.A.
FHLB - Federal Home Loan Bank Board
Fidelity - Fidelity New York, F.A.
FRBNY - Federal Reserve Bank of New York
Freeport - First Federal Savings & Loan Association of Freeport
GAAP - generally accepted accounting principles
GNMA - Government National Mortgage Association
Hamilton - Hamilton Bank
Harrisburg - City of Harrisburg, Pennsylvania
Huntington - Huntington Savings & Loan Association
Lesney - Lesney Products Corp.
Mainland - Mainland Savings & Loan Association
Merritt - Merritt Commercial Savings & Loan Association
NASD - National Association of Securities Dealers, Inc.
N.J.U.C.C. - Uniform Commercial Code of New Jersey, N.J.S.A. 12A:1-101, et seq.
N.Y.U.C.C. - Uniform Commercial Code of New York, N.Y Consolidated Laws,
Uniform Commercial Code § 1-101, et seq. (McKinney Supp. 1986)
Perth Amboy - First Savings & Loan of Perth Amboy
PSA - Public Securities Association
Prudential - Prudential Federal Savings & Loan Association
Repo - Repurchase transaction in government or agency securities
Repo Committee - Unofficial Committee of Repurchase Participants
Repo participant - Participant in repurchase transaction with AMC or BBS, Inc.
Reverse repo - Reverse repurchase transaction in government or agency securities
Reverse Repo Committee - Official Committee of Reverse Repurchase Participants
Reverse repo participant - Participant in reverse repurchase transaction with AMC
or BBS, Inc.
SEC - Securities and Exchange Commission
SIPA - Securities Investor Protection Act
SIPC - Securities Investor Protection Corporation
SPCSC - Security Pacific Clearing and Services Corporation
SPEED - Security Pacific Easy Electronic Delivery
SPNTCo. - Security Pacific National Trust Co.
Universal - Universal Savings & Loan Association
Worthen - Worthen Bank & Trust Company, N.A.
DEBEVOISE, District Judge.
I. INTRODUCTION
Motions and cross-motions for summary judgment or partial summary judgment have been filed in two separate adversary proceedings: one instituted in the proceeding for the liquidation of Bevill, Bresler & Schulman, Inc. ("BBS, Inc.") pursuant to the Securities Investor Protection Act ("SIPA"), 15 U.S.C. § 78aaa, et seq., and the other instituted in the proceeding for reorganization of Bevill, Bresler & Schulman Asset Management Corporation ("AMC") under Chapter 11 of the Bankruptcy Code ("the Code"), 11 U.S.C. § 101 , et seq. The BBS, Inc. Trustee moves for *563 summary judgment or partial summary judgment with regard to four series of securities transactions involving BBS Inc. which have been designated as `test cases' in the BBS, Inc. liquidation proceeding. The AMC Trustee similarly moves for partial summary judgment with regard to five such `test cases' in the AMC reorganization proceeding. The unofficial Committee of Repurchase Participants (the "Repo Committee"), Champlain Valley Federal Savings & Loan Association of Plattsburgh ("Champlain"), First Federal Savings & Loan Association of Freeport ("Freeport") and Lesney Products Corp. ("Lesney") (hereinafter collectively referred to as the "Repo Committee") jointly cross-move for summary judgment on behalf of participants in repurchase transactions with BBS, Inc. and/or AMC. The City of Harrisburg, Pennsylvania ("Harrisburg"), also cross-moves for summary judgment in the adversary proceeding initiated by the BBS, Inc. Trustee. Due to the similarity of the issues and competing claims involved in the test cases, the hearings on the motions and cross-motions were consolidated, and this opinion sets forth the decision with regard to all of them.
II. PROCEDURAL BACKGROUND
On April 7, 1985, AMC filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. On application of the Securities and Exchange Commission ("SEC") made on April 8, 1985, AMC's Chapter 11 case was withdrawn from the Bankruptcy Court to the District Court pursuant to 28 U.S.C. § 157 (d). On April 9, 1985, Saul S. Cohen, Esq., was appointed Chapter 11 Trustee of AMC. On April 10, 1985, Mr. Cohen was also appointed equity receiver of AMC's parent corporation and one other related corporation.
On April 8, 1985, the SEC filed a verified complaint against BBS, Inc., AMC, the five principals of BBS, Inc. and AMC, and other related corporations and partnerships owned or controlled directly or indirectly by the principals. The complaint alleged securities fraud in violation of the Securities Act of 1933 and the Securities and Exchange Act of 1934. Richard W. Hill, Esq., was appointed Temporary Receiver of BBS, Inc. and three related corporations in the SEC action on April 10, 1985. An involuntary petition in bankruptcy was filed against BBS, Inc. on May 2, 1985. On May 6, 1985, the Securities Investor Protection Corporation ("SIPC") filed an application for a protective decree pursuant to 15 U.S.C. § 78eee. On May 8, 1985 an order was entered adjudicating the customers of BBS, Inc. to be in need of protection under SIPA, and Mr. Hill was appointed Trustee for the SIPA liquidation of BBS, Inc.
On May 3, 1985 the AMC Trustee commenced the above adversary proceeding in the AMC reorganization proceeding, naming all known creditors of AMC as defendants. The complaint seeks a judgment "determining the extent, validity and priority of the liens, ownership interests or other legal interests of the defendants in and to assets of the estate including government securities in the possession, control or custody of the Trustee and/or subject to repurchase agreements with the debtor." Status conferences in both the AMC reorganization and BBS, Inc. liquidation proceedings were jointly held on September 4, 1985 and October 15, 1985 for the purpose of (1) identifying certain categories of securities transactions in which the debtors were engaged which raise legal issues common to the claims of particular classes of creditors, and (2) selecting representative securities transactions within each category as `test cases' which would be litigated on an expedited basis. The AMC Trustee in consultation with the official and unofficial creditors' committees selected five such transactions to serve as test cases within the omnibus adversary proceeding brought by the Trustee.
On November 7, 1985, the BBS, Inc. Trustee commenced the above adversary proceeding in the BBS, Inc. liquidation proceeding. The Trustee's complaint seeks a declaratory judgment defining the rights and interests of various parties who were involved in five `test case' securities transactions with BBS, Inc.
*564 The AMC Trustee moves for summary judgment: (1) authorizing the Trustee to reject the reverse repurchase agreements respecting the securities underlying the `test case' transactions pursuant to 11 U.S.C. § 365 (a); (2) adjudging that the securities are property of the estate within the meaning of 11 U.S.C. § 541 ; and (3) declaring that those parties to the test cases who engaged in repurchase and reverse repurchase transactions with AMC ("repo participants" and "reverse repo participants") are general creditors of the estate with no ownership or other legal interest in or to the test case securities or their proceeds. In support of his motion the AMC Trustee has submitted: (1) the affidavit of Larry Dean Pugh, a government securities trader and market consultant to the Trustee, in which he describes the industry practices of dealers in government securities with regard to the transfer and/or use of securities which are acquired pursuant to reverse repurchase agreements ("reverse repos"); (2) five separate affidavits of Henry Green, a consultant to the Trustee retained to assist him in reconstructing the books and records of AMC, in which he describes the documentation available to the Trustee relating to the repurchase transactions ("repos") and reverse repos which are the subject of each of the five test cases in the AMC adversary proceeding: (3) the affidavit of Joseph Guardino, submitted on behalf of Security Pacific Clearing and Services Corporation ("SPCSC"), in which he summarizes the clearing and safekeeping functions performed by SPCSC for securities dealers such as BBS, Inc. and AMC, and describes SPCSC's usual operating procedures, generation of documents and document flow in transactions like those at issue in the test cases; (4) the affidavit of Charles M. Viviano, Managing Director and Chief Executive Officer of SPCSC, in which he incorporates a statement presented to the Commerce, Consumer and Monetary Affairs Subcommittee of the House Committee on Government Operations describing in general terms the financing, clearing and safekeeping functions performed by SPCSC pursuant to its contracts with securities dealers; and (5) the affidavit of Robert J. Franz, a Manager with the accounting firm of Laventhol & Horwath.
The BBS, Inc. Trustee similarly moves for summary judgment in favor of the Trustee with respect to four of the five test cases covered in his complaint, or, in the alternative, for partial summary judgment declaring that: (1) the repos and reverse repos involved in the test case transactions are collateralized loans and not purchases and sales; (2) repo participants and reverse repo participants in the test cases are not customers of BBS, Inc. within the terms of SIPA; (3) repo participants who did not take actual possession of the underlying securities neither perfected their interests in the securities under New Jersey law nor acquired any interest under New York law; (4) the Trustee's rights to the securities underlying the reverse repos are superior to those of the reverse repo participants; and (5) the Trustee's rights to the proceeds remitted to him pursuant to 11 U.S.C. § 559 are superior to those of the reverse repo participants.
In support of his motion, the BBS, Inc. Trustee has submitted: (1) the reports of Marcia Stigum and Robert Geiger, who were retained by the Trustee as experts on the subject of the repo market in government and agency securities, in which they set forth their views of the economic substance of repo transactions and the proper characterization of such transactions; (2) two affidavits of Roger M. Landon, a past Assistant Manager of Operations for BBS, Inc. and a Vice-President at the time of its collapse, in the first of which he reviews the existing documentation relating to the repos and reverse repos underlying the four test cases which are the subject of the Trustee's present motion, and in the second of which he sets forth facts relating to instances in which BBS, Inc. made substitutions of securities subject to both possessory and non-possessory repo transactions; (3) the report of Raymond E. Perry of the accounting firm of Touche Ross & Co. regarding current accounting practices in accordance *565 with generally accepted accounting principles for repos and reverse repos by broker/dealers, commercial banks, savings and loan associations, mortgage bankers and state and local government entities; (4) the report of John L. Manley also of Touche Ross & Co. which addresses the accounting treatment of repos and reverse repos in the certified financial statements and books and records of BBS, Inc.; and (5) the affidavit of Dianne M. Boitz of Touche Ross & Co. which supplements the information and documentation contained in the Landon affidavit.
The Repo Committee cross-moves in both the AMC and BBS, Inc. adversary proceedings for summary judgment: (1) declaring that repo participants are customers under the terms of SIPA; (2) declaring that repo participants have, pursuant to either New York or New Jersey law, effectuated transfer or delivery of the securities underlying the repo transactions at issue in the test cases, or, in the alternative, perfected security interests in the securities; and (3) imposing a constructive trust on the securities claimed by Champlain and Freeport. In support of its cross-motion, the Repo Committee has submitted the affidavit of Clifford H. Goldman, Executive Vice President of Lehman Government Securities, Inc., in which he incorporates his written report to the Trustee which describes the nature and size of the repo market, the mechanics of repo transactions and custodial arrangements for the safekeeping of securities involved in such transactions, and the importance of the repo market as a mechanism for financing the national debt, implementing monetary policy and stimulating investment in the domestic housing market, and sets forth his opinions with regard to the proper economic characterization of repo transactions.
Harrisburg cross-moves for summary judgment declaring that it is a customer of BBS, Inc., within the terms of SIPA, and has submitted in support of its cross-motion the report of William J. Rafferty, a Partner in the accounting firm of KMG Main Hurdman, in which he describes the accounting treatment of repos and reverse repos by state and local governments.
The Federal Reserve Bank of New York ("FRBNY") has submitted a memorandum of law as amicus curiae accompanied by (1) the affidavit of Peter D. Sternlight, Executive Vice President of FRBNY, in which he describes the role of the repo market as a vehicle for financing the national debt and adjusting the level of bank reserves in order to achieve monetary policy goals, stresses the importance of maintaining liquidity and flexibility in the market for government securities, and expresses his view regarding the proper characterization of repo transactions, and (2) the affidavit of Daniel C. Bolwell, Chief of the Securities Transfer Department of the FRBNY, in which he sets forth the minimum denominations of the Federal Home Loan Bank Board security and the two Treasury debt securities involved in the test cases.
SIPC has submitted papers in the BBS, Inc., adversary proceeding in support of the Trustee's summary judgment motion.
The Official Committee of Reverse Repurchase Participants in the AMC reorganization proceeding (the "Reverse Repo Committee") has submitted papers on behalf of reverse repo participants in opposition to the AMC Trustee's motion for partial summary judgment and the Repo Committee's cross-motion for summary judgment, and papers as amicus curiae in the BBS, Inc. proceeding in partial opposition to the BBS, Inc. Trustee's motion. In support of its position, the Reverse Repo Committee has submitted: (1) separate affidavits of representatives of the five reverse repo defendants in the AMC test cases setting forth their respective purposes in entering reverse repos with AMC, their understandings with regard to the nature and substance of the reverse repos to which they were a party, and their bookkeeping and accounting treatment of reverse repos; (2) the affidavit of Michael S. Huber, a Partner in the accounting firm of KMG Main Hurdman, in which he incorporates his report to the Committee regarding generally *566 accepted accounting principles ("GAAP") applicable to repo transactions and the accounting treatment accorded such transactions by AMC; (3) the affidavit of David I. Meiselman, Professor of Economics and Director of the Graduate Economics Program at Virginia Polytechnic Institute and State University, in which he incorporates his report to the Committee on the economic substance of repos and reverse repos; and (4) the affidavit of H. Peter Haveles, Jr., Esq., pursuant to Fed. R.Civ.P. 56(f) in which he asserts that additional discovery is necessary before the Committee can present facts essential to its opposition to the AMC Trustee's motion for partial summary judgment.
Worthen Bank & Trust Company, N.A. ("Worthen") and Prudential Federal Savings & Loan Association ("Prudential") have filed papers in opposition to the summary judgment motions of both Trustees. Cuero Federal Savings & Loan Association ("Cuero") opposes the motion of the AMC Trustee for summary judgment. Fidelity New York, F.A. ("Fidelity"), Bayamon Federal Savings & Loan Association of Puerto Rico ("Bayamon") and Huntington Savings & Loan Association ("Huntington") have each submitted papers in the BBS, Inc. proceeding in opposition to the Trustee's motion.
III. FACTUAL BACKGROUND
A. The Debtors
BBS, Inc., a New Jersey corporation, was a securities broker-dealer registered with the SEC under the Securities and Exchange Act of 1934 and a member of SIPC and the National Association of Securities Dealers, Inc. ("NASD"). BBS, Inc., maintained its principal corporate offices in Livingston, New Jersey, and, as of April 8, 1985, also maintained offices in New York City, Houston, Texas, and Palm Beach and Fort Lauderdale, Florida. Trading activities were conducted at each location. Landon Dep. at p. 17, 11.20-21. BBS, Inc., also maintained a vault at 100 William Street in New York City out of which it conducted certain in-house securities functions, principally involving municipal securities. Id. at p. 18, 11 .5-20. Prior to the appointment of Mr. Hill as Temporary Receiver, BBS, Inc. engaged in a variety of securities and related financial transactions with and on behalf of its customers. Its customers included individual retail customers and various institutional investors such as municipal authorities, commercial banks, and savings and loan associations. A large part of BBS, Inc.'s business involved financial transactions with government securities â either outright sales and purchases, or transfers made pursuant to repo and reverse repo transactions.
AMC, also a New Jersey corporation, was an unregulated secondary dealer in government securities. It was neither registered with the SEC, nor a member of SIPC or NASD. AMC is a corporate affiliate of BBS, Inc. The parent corporations of both AMC and BBS, Inc. were owned by the same five individual principals. Both corporations operated out of the same offices in Livingston, New Jersey. AMC had no employees of its own but utilized the staff of BBS, Inc. to effectuate trades. Id. at p. 23-24 . Whether a particular trade was processed through AMC or BBS, Inc. depended principally upon which corporation had possession of, control over or access to the particular securities. Id. at p. 28, 11 .22-25. Unlike BBS, Inc. which offered a full panoply of investment services to its customers, AMC was engaged primarily in the trading of government securities through repo and reverse repo transactions.
B. Repos and the Repo Market
Each of the present test cases involves competing claims of ownership or entitlement to securities (or the proceeds of the sale thereof) utilized in repo or reverse repo transactions between the debtors and the individual defendants. A standard repo consists of a two-part transaction. The first part consists of the transfer of specified securities by one party, the seller, to another party, the buyer, in exchange for cash. The second part consists of the contemporaneous *567 agreement by the seller to repurchase the securities at the original price, plus an agreed upon amount of interest, on a specified future date. The amount of the original repo price is typically less than the prevailing market value of the securities. This differential is sometimes referred to in the trade as the "hair-cut." Meiselman Rep., para. 3(b) at p. 2. The repurchase price paid at the maturity date of the repo agreement consists of the original purchase price amount plus interest calculated at a predetermined rate from the original trade date to the maturity date of the repo transaction. The interest paid at the maturity date of the repo agreement does not bear any relationship to the interest rate or yield paid on the underlying security, but rather is based on the prevailing market rate paid on investments or financing transactions of similar maturity and risk. Meiselman Rep., para. 3(c) at p. 3. A standard reverse repo consists of the same two-part transaction viewed from the perspective of the buyer. Thus, when one sells a security and agrees to buy it back he is engaged in a repo transaction. When the same party buys a security and agrees to sell it back, he is engaged in a reverse repo transaction.
The terms "repo" and "reverse repo" will be used in this opinion to describe the transactions from the perspective of the bankrupt dealers. That is, in their repo transactions, AMC and BBS, Inc. (as seller) "repoed out" securities to repo participants (as buyers) and simultaneously agreed to repurchase the securities on future dates. Conversely, in their reverse repo transactions, securities were "reversed in" to AMC and BBS, Inc. (the buyers) from reverse repo participants (the sellers) who agreed to repurchase the securities on the maturity date of the reverse repo agreements.
The repo market in government and agency securities performs several vital functions in the nation's economy. The United States Treasury relies heavily on the repo market as a tool for financing the national debt at the lowest possible cost. Sternlight Affidavit, para. 7 at p. 4. New issues of Treasury debt securities in the form of short-term Treasury Bills (obligations with a maturity of up to a year), medium-term Notes (obligations with a maturity of one to ten years) and long-term Bonds (obligations with a maturity of more than 10 years) are initially offered to approximately 36 primary dealers at auction. As the national debt has grown, Treasury auctions have become more frequent and of greater size. The amount of securities purchased by primary dealers at any one Treasury auction often aggregates in the tens of billions of dollars. Goldman Rep. at p. 8. The primary dealers themselves do not have the funds required for the outright purchase of these securities at auction. Nor are commercial banks capable of providing the amount of funds needed by primary dealers to purchase the huge amounts of Treasury securities sold at auction. In addition, to the extent that primary dealers must resort to bank loans to finance their securities purchases, the cost associated with this borrowing would be higher, the amounts they are willing to bid for Treasury securities will be lower, and the interest rates for Treasury securities will necessarily be higher. Goldman Rep. at 9. As an alternative to commercial bank loans, primary dealers have relied heavily on temporary financing through repo transactions with secondary dealers such as BBS, Inc. and AMC and institutional customers pending resale of the issues to other investors. Sternlight Aff., para. 6 at p. 3.
The repo market has also proven to be a highly effective and flexible short-term tool for the execution of monetary policy by the Federal Reserve system. The Federal Open Market Committee makes extensive use of repos and reverse repos in regulating the level of bank reserves. Goldman Rep. at 10. In order to smooth seasonal or unexpected fluctuations in the monetary supply, which in turn causes short-term fluctuations in interest rates and the rate of inflation, the Federal Reserve will engage in reverse repo transactions as a buyer to increase bank reserves or initiate repo transactions as a seller to decrease bank *568 reserves. Stigum Rep. at 14. During 1985, the Federal Reserve entered the repo market approximately 150 times. Goldman Rep. at 10. Federal Reserve operations in the market on a single day through repo or reverse repo transaction often came to $3-4 billion and have reached as high as $7.9 billion. Sternlight Aff. para. 4, p. 3.
The repo market also contributes to a strong domestic housing market by enhancing the liquidity of mortgage-backed securities insured by government sponsored agencies such as the Government National Mortgage Association ("GNMA") (referred to generically as "agency securities"). Any market disruptions which restricted the liquidity of these securities would increase the yield needed to attract investors, and, as a result, mortgage lending institutions would be forced to charge higher interest rates on consumer mortgages. Goldman Rep. at 12.
The ability to tailor the maturity of repos and to vary amounts invested from day to day make them especially suitable to the investment needs of entities experiencing seasonal and unpredictable cash flows. The short-term yield, liquidity and flexibility of repo transactions combined with the meteoric increases in the federal debt have led to dramatic increases in the daily volume of repo trades. Repo and reverse repo transactions by primary dealers alone are estimated to aggregate more than $300 billion daily. In contrast, the average daily value of shares traded on the New York Stock Exchange and American Stock Exchange combined is approximately $12 billion. Goldman Rep. at 7.
As alluded to above, participants in the repo market fall into three broad categories: primary dealers, secondary dealers and institutional customers. The 36 primary dealers are selected by the Federal Reserve to distribute new issues of Treasury debt and act as "market-makers" for government securities. They generally enter major transactions with large institutional investors. The FRBNY monitors the activity and financial soundness of primary dealers through on site visits and required daily, monthly and annual reports setting forth their transactions, positions and capital. Goldman Rep. at 12.
There are estimated to be approximately 200 secondary government securities dealers. These secondary dealers do not deal directly with the Federal Reserve. Id. at 13 . BBS, Inc. and AMC were secondary dealers. Savings and loan associations and state and local governments make up a significant portion of customers engaging in repo transactions with secondary dealers. Government securities investors in the secondary repo market also include money market and mutual funds, pension funds, insurance, financial and other corporations, and foreign investors.
The securities involved in repo and reverse repo transactions are of two types: certificated securities and book entry securities. Certain mortgage-backed securities guaranteed by such agencies as GNMA are issued in the form of tangible paper certificates. The certificates generally represent an interest in a specific pool of government insured or guaranteed mortgages. These securities are typically referred to as "pass through" securities in that the holder of a certificate is entitled to direct payment of his/her share of principal and interest paid on the underlying mortgages in a given pool. Six of the nine securities at issue in the present test cases are certificated GNMA securities.
Book-entry securities, on the other hand, are uncertificated securities which are recorded as messages or data stored in a computer. Book-entry securities are maintained through the Federal Reserve book-entry system. [1] Within this system, each Federal Reserve Bank establishes and maintains book-entry accounts for "depository *569 institutions," within its district. Pursuant to 12 U.S.C. § 461 , eligibility to maintain a direct account at a Federal Reserve Bank is limited to institutions which are eligible for federal deposit insurance, including commercial banks, trust companies, savings banks, savings and loan associations and credit unions. There is no corresponding restriction on the individuals and entities that may maintain book-entry accounts at depository institutions.
The Federal Reserve book-entry system involves a tiered system of accounts. Interests of a depository institution in book-entry securities are recorded on the books of a Reserve Bank, and interests of the customers of the depository institution are recorded on the books of that institution. The depository institution acquires control over disposition of the securities in its book entry accounts at a Federal Reserve Bank, as well as the right to receive principal and interest payments. The depository institution in turn is accountable to its customers for both the securities and payments it receives. If a customer of a depository institution is another bank, or a securities dealer, the bank or securities dealer may also maintain book-entry accounts for its customers, based on the securities maintained for it by the depository institution.
Book entry securities are transferred through a computer network, called "Fedwire," which connects the 12 Federal Reserve Banks (and their branch banks) with the depository institutions. In processing a book-entry transfer transaction, a Reserve Bank makes up to four entries on the securities and reserve accounts of depository institutions. If securities are transferred "free," the Reserve Bank debits the securities account of the sending depository institution and credits the securities account of the receiving depository institution in the aggregate principal amount specified in the transfer instruction transmitted by the sending institution. If the securities are transferred against payment, the Reserve Bank also credits the reserve account of the sending depository institution and debits the reserve account of the receiving depository institution in the dollar amount specified in the instruction. In turn, the depository institutions "are expected to maintain appropriate records in regard to their customers, covering such matters as transfer of the securities, pledge interests in the securities, and redemption of the securities and payment of interest thereon." Operating circular ("O.C.") No. 21 of the FRBNY, para. 3(c).
The majority of all Treasury debt securities are now issued in book-entry form. Certain mortgage-backed "agency" securities such as those guaranteed by the Federal Home Loan Bank Board ("FHLB") are also issued in book entry form and transferred over the Fedwire. Of the nine securities at issue in these test cases, two are Treasury debt securities and one is an FHLB security.
Government and agency issued securities are exempt from the registration and periodic reporting requirements of the federal securities laws. Similarly, firms that deal only in government or other exempt securities are free from comprehensive oversight or regulation, and there presently are no uniform or comprehensive margin or capital requirements with which such dealers must comply. See, e.g., Federal Reserve Bank of Atlanta, Economic Review, Sep. 1985, p. 7; Regulation of the Government Securities Market: Report by the SEC to the Subcommittee on Telecommunications, Consumer Protection and Finance of the House Committee on Energy and Commerce, June 20, 1985, Exhibit 1, p. 11 (Goldman Rep., Exhibit D). Often such dealers are thinly capitalized and their securities inventories are highly leveraged. Goldman Rep. at pp. 28-29; FRB of Atlanta, Economic Review, Sept. 1985, p. 7.
Secondary dealers in government securities generally do not have available cash from working capital or unsecured borrowings to cover the size of most reverse repurchase transactions. Instead, they finance reverse repo transactions with cash obtained by "repoing out" or selling outright the securities they receive under reverse repo agreements. It is for this reason *570 that reverse repo agreements customarily contain no restrictions on the dealer's right to transfer or encumber the securities obtained through reverse repo transactions. Pugh Aff., śś 4-5.
As a matter of custom and usage in the industry, securities dealers such as AMC and BBS, Inc. do not ordinarily hold securities acquired through a reverse repo agreement to the maturity date of the reverse repo. Securities may be and are in practice often transferred by the dealer to a repo customer or another dealer who may in turn transfer them to its own repo customer. There is theoretically no limit on the number of repo transactions to which a security may become subject after it is acquired by a dealer under a reverse repo transaction. Each subsequent repo party may take physical possession of the security, so that the dealer's original reverse repo customer will in the customary transaction be totally unaware of the physical location of the securities or the existence and terms of the subsequent transactions to which the security is subject. In practical effect, the reverse repo participant relinquishes to the dealer all control over the security during the term of the reverse repo agreement. Pugh Aff., ś 5; Goldman Rep. at 28-29. The dealer is obligated only to return the security or, if fungible, a security of equivalent value upon the maturity date of the reverse repo agreement. Goldman Rep. at 28.
There are generally two types of possible custodial arrangements involved in typical repo transactions: possessory or delivery repo transactions and non-possessory or safekeeping repo transactions.
In a delivery repo transaction, the dealer transfers the securities to the repo participant or its agent at the outset of the transaction. Certificated securities are physically delivered by the dealer or its agent to the repo participant or its agent. Book-entry securities are wired against simultaneous payment between the book-entry accounts of the depository institutions where the dealer and the repo participant maintain their respective book-entry accounts. In either case, the delivery of securities necessarily entails certain transfer costs. See generally, Goldman Rep., pp. 17-19, 31-32.
In a non-possessory repo transaction, the dealer retains the securities for the account of the repo participant. The non-possessory repo is an attractive alternative to the delivery repo for a number of reasons. Delivery of securities may be impractical given the difficulty in effecting transfer quickly enough to accommodate the short settlement periods of many repo transactions. In addition, the parties may wish to avoid the transaction costs associated with delivery. Id.
Under non-possessory repo transactions, dealers frequently do not physically retain the securities. Many dealers utilize the services of clearing entities to facilitate the movement of securities and funds involved in the processing of repurchase transactions. The services provided government securities dealers by such clearing firms include the receipt and delivery of securities, payment for securities, and collection or transfer of funds for securities sold. These transactions are accomplished through an account maintained by the clearing firms for each of their dealer customers ("clearing accounts"). Clearing firms also provide financing to their dealer customers by making payment for delivered securities even if the dealer does not have sufficient funds on deposit with the clearing firm. This financing is provided through a line of credit ("clearing loans") collateralized by securities owned by the dealers which are deposited in the dealers' clearing accounts. Generally, the loan and securities balances in each clearing account fluctuate daily as securities and funds are transferred into and out of the account at the request of the dealer.
In addition to their clearing function, clearing firms typically make available to their dealer customers segregation accounts for the safekeeping of securities which are fully paid for by the dealer's own customers and are not to be valued or used as security by the clearing firms for the *571 clearing loans to their dealer customers. Safekeeping of securities is frequently accomplished by way of "omnibus safekeeping" arrangements. Under such arrangements, the clearing firm places securities in safekeeping accounts for the benefit of its dealer customers labelled according to the name of the dealer from which or for whom the securities were received. No further information is recorded. Certificated securities are typically physically segregated by either tagging the specific securities or placing the securities in separate envelopes or folders. Safekeeping of book-entry securities is accomplished by a book-keeping arrangement where the clearing firm records the securities as being held in safekeeping for the account of a particular dealer. If the clearing firm is not a depository institution, it might also instruct the depository institution where it maintains its book entry accounts to record the interest of the dealer in the securities.
Under most omnibus safekeeping arrangements, the clearing firm acts solely on instructions from, and on behalf of, its dealer customers to receive and deliver securities and funds. The clearing firm does not accept instructions from and has no knowledge of, or relationship with, the customers of its dealer customers. The dealer manages and controls its relationship with its own customers.
Under some safekeeping arrangements, certain clearing firms maintain subaccounts or adopt bookkeeping practices which identify in some fashion the customers of their dealer customers. The degree of segregation identification varies according to the practice of the individual clearing firm and, in some cases, upon the amount of information given to the clearing firm by the dealer from which the instruction to segregate was received. The clearing firm may either segregate securities for the account of the dealer only (as in the usual omnibus safekeeping arrangement), for the dealer's customers in general or for the dealer's customers individually by customer name.
Safekeeping of securities is sometimes accomplished pursuant to tripartite repo agreements under which the dealer, the repo participant and the clearing firm enter into a master agreement which governs the terms and conditions of the repurchase of the securities. Under such an agreement, the purchased securities are delivered by the dealer to the clearing firm which acts as an agent for both participants and maintains an account for the dealer and an account for the repo participant. See, Goldman Rep., pp. 19-20.
C. The Test Cases
1. Overview.
On the filing dates of the AMC reorganization proceeding and the BBS, Inc. liquidation proceeding, the debtors were in the midst of numerous open repo and reverse repo transactions. Performance under the repo and reverse repo agreements which are the subject of the instant test cases had not been completed. Thus, the debtors had not paid the repo participants the principal amounts of the repurchase agreements and the interest due thereon in exchange for the securities, and, correspondingly, had not returned the securities to the reverse repo participants in exchange for the principal amount of the reverse repurchase agreements and the interest due thereon.
Generally, the repo and reverse repo transactions in which the debtors were engaged were memorialized in three categories of documents: (1) a trade ticket; (2) two separate confirmations generated on or about the same day as the trade date and sent to the customer contemporaneously; and (3) standard forms of agreement.
The trade tickets generated by AMC and BBS, Inc. generally set forth the name of the repo or reverse repo customer, a description of the security involved in the transaction, and the terms of the transaction. The initial price paid for the security is denominated on the trade tickets as "$'s financed."
The two confirmations issued by BBS, Inc. and AMC memorialized the two parts *572 of each repo or reverse repo transaction. In addition to the information contained on the trade tickets, the confirmations also set forth delivery instructions, if any, relating to the custody of the security during the duration of the repo or reverse repo transaction. The confirmation slips were framed in the language of a purchase and sale. Thus, with regard to reverse repurchase transactions, the first confirmation stated the terms of the acquisition by AMC or BBS, Inc. of the security, and contained a capacity code which noted that "as principal for our own account we have bought from you." The second confirmation stated the terms of the reverse repo customer's agreement to reacquire the security at a future date and contained a capacity code which read "As principal for our own account we have sold to you." Similarly, with regard to repo transactions, the first confirmation stated the terms of the repo customer's acquisition of the security and contained a capacity code "as principal for our own account we have sold to you." The second confirmation stated the terms of the agreement by AMC and BBS, Inc. to reacquire the security and contained the capacity code "as principal for our own account we have bought from you." However, the amount to be paid on the maturity of the repo or reverse repo transaction in addition to the original fixed principal amount is denominated on the confirmations as the "interest" or "repo interest." The confirmation slips also contain a proviso which reserves to AMC or BBS, Inc. the right to hypothecate the subject securities "under circumstances that will permit the commingling thereof with securities carried for the account of other customers."
The Repurchase and Reverse Repurchase Agreements memorialize only the second part of the repo or reverse repo transactions. The standard Repurchase Agreement sets forth the terms of the agreement of AMC or BBS, Inc. to reacquire the security from the repo customer. In these Agreements, AMC or BBS, Inc. were termed the "buyer" and the repo customer was termed the "seller." BBS, Inc. and AMC reserved to themselves a "right of substitution." In addition, any maturing coupons were to be the property of AMC and BBS, Inc. Lastly, the standard Repurchase Agreement provided that the securities could be sold by the repo participant upon default of the obligation of AMC or BBS, Inc. to repurchase the security.
The standard Reverse Repurchase Agreement identifies BBS, Inc. or AMC as "the seller" and the reverse repo participant as "the buyer." The Agreement provided that maturing coupons were to be the property of the reverse repo participant, and that BBS, Inc. or AMC could sell the security upon default of the obligation of the reverse repo participant to repurchase the security. Under the Agreement, any margin or other funds of the reverse repo participant held by BBS, Inc. or AMC could be applied by BBS, Inc. or AMC to offset any loss sustained by virtue of a default. In addition, the standard Reverse Repurchase Agreement states that BBS, Inc. or AMC may request additional margin any time during the life of the agreement. Unlike the standard Repurchase Agreement, the Reverse Repurchase Agreement did not confer upon AMC or BBS, Inc. an express "right of substitution."
Prior to the filing dates of the AMC reorganization proceeding and the BBS, Inc. liquidation proceeding, both dealers utilized the clearing, financing and custodial services of SPCSC. SPCSC, with offices and principal operations in New York City, is a clearing firm which clears transactions in government and agency securities and municipal securities. Guardino Aff., ś 3. Both AMC and BBS, Inc. previously used as their clearing agent Bradford Trust Company ("Bradford"), a New York corporation having its principal place of business in New York City. Bradford withdrew from its clearing agency business with AMC and BBS, Inc. in or around March, 1985, but had previously arranged for the transfer of that business to SPCSC.
On May 22, 1984, SPCSC entered into a "Clearing, Custody and Financing Agreement" with AMC and an identical agreement with BBS, Inc. ("the Clearing Agreements") *573 pursuant to which SPCSC established and maintained separate clearing and safekeeping accounts for both dealers. All four of these accounts were for transactions in government or agency securities. AMC and BBS, Inc. transacted some business with SPCSC following the execution of the Clearing Agreements, but the volume of business remained at a comparatively low level until March 1985 when Bradford terminated its relationship with the two dealers.
With regard to the clearing accounts maintained by SPCSC, paragraph 6 of the Clearing Agreements granted SPCSC a "security interest in, and a lien upon" the securities in SPCSC's possession, and continued, in relevant part:
Regarding Collateral [i.e., clearing account securities] in SPCSC's possession or control, SPCSC shall use reasonable care in the custody and preservation of such collateral, but need not take any steps necessary to preserve rights against third parties, unless instructed by [AMC or BBS, Inc.] . . . SPCSC may use and deal with the collateral and bear the risk and benefit thereof . . . without retaining possession or control of a like amount of collateral and without notice to [AMC or BBS, Inc.].
Paragraph 4(c) further granted SPCSC the unilateral right to disregard AMC's or BBS, Inc.'s instructions to place securities in safekeeping or to deliver securities from the clearing accounts to the dealers' customers:
SPCSC need not remove any collateral (as defined in Paragraph 6 hereof) from the [lien] of SPCSC, including by designating such as customer securities or fully paid securities or by effecting the delivery thereof free of payment, if after giving effect thereto SPCSC shall deem itself less than adequately secured or [AMC or BBS, Inc.] shall not be in compliance with SPCSC's credit policies. Any instruction from [AMC or BBS, Inc.] in contravention of the foregoing shall be of no force or effect regardless of any action by SPCSC.
With regard to the safekeeping accounts maintained by SPCSC, the Clearing Agreements allowed SPCSC to "hold securities which [AMC or BBS, Inc.] identifies in writing to SPCSC as fully paid securities by entering same on its books in a denominated account" (para. 3(h)). The agreements expressly provided that the security interest of SPCSC "shall not extend to securities which SPCSC in accordance with [AMC's or BBS, Inc.'s] instructions shall have entered on its books as a denominated account for fully paid securities" (para. 6). Securities in such segregated accounts were not to be "reclassified or otherwise disposed of except upon receipt by SPCSC of [AMC's or BBS, Inc.'s] written instructions" (para. 3(h)). Under the Clearing Agreements, AMC and BBS, Inc. represented and warranted that securities delivered to SPCSC were unencumbered by "any rights, claims or interest of any third party except the rights of [AMC's or BBS, Inc.'s] customers in securities which SPCSC shall have entered on its books as an account denominated fully paid securities" (para. 9(c)).
SPCSC generally received instructions to take delivery of certificated securities in one of three ways: (1) by hand delivery of preprinted "Receive Ticket" filled out by AMC or BBS, Inc.; (2) by receipt of handwritten instructions from AMC or BBS, Inc. transmitted by telecopier ("DEX Instructions"); or (3) by oral instruction over the telephone, from which Receive Tickets were generated by an SPCSC account manager. Guardino Aff., para. 7. The instructions customarily identified the customer account (clearing or safekeeping) into which the security was to be placed. Upon receipt of the securities from the contra party of AMC or BBS, Inc., SPCSC placed them in the appropriate account in the SPCSC vault. Securities in the vault were filed according to account and maintained in a separate file from all other accounts belonging to AMC or BBS, Inc. and all other customers of SPCSC. Within each account file, securities were arranged according to type (e.g., GNMA securities *574 were filed together) and within the type of security the files were maintained in ascending order of pool number. Id., para. 17.
Instructions by AMC or BBS, Inc. to move a security from one account to another (i.e., from clearing to safekeeping or vice versa ) were also transmitted to SPCSC by oral or written instructions. Upon receipt of such an instruction, typically a "Seg Move Ticket" would be prepared by an SPCSC account manager to accomplish the movement. Id., para. 15. When SPCSC vault personnel received the Seg Move Ticket, the certificate was physically moved from its original account file to the separate file of the account designated on the Seg Move Ticket. Id., para. 17.
For purposes of processing book-entry transactions on behalf of its dealer customers, SPCSC maintains book entry accounts at its bank, Security Pacific National Trust Co. ("SPNTCo."), which, as a depository institution, in turn maintains book entry accounts at a Federal Reserve Bank. SPCSC processes the book-entry transactions of its customer through a service known as the "SPEED" (Security Pacific Easy Electronic Delivery) system, which operates as a computer interface with Fedwire. SPCSC's customers' book-entry transactions are processed through SPCSC's book-entry accounts at SPNTCo. Each customer of SPCSC is assigned a sub-title to which its book-entry transactions are allocated by the SPEED system within SPCSC's book-entry accounts. Guardino Aff., para. 18.
SPCSC received instructions from AMC and BBS, Inc. to take delivery of a book-entry security in the same manner it received notice to take delivery of a certificated security: AMC or BBS, Inc. either delivered a Receive Ticket to SPCSC setting forth the anticipated date of receipt of the book-entry security, or transmitted a DEX Instruction to SPCSC to receive the security. Id., para. 19. The information on the Receive Ticket or on the DEX Instruction was then put into the SPEED system, and upon electronic transfer of the book-entry security by the depository institution of the contra party a so-called SPEED Ticket was generated evidencing delivery of the security to SPCSC's book-entry account at SPNTCo. for AMC or BBS, Inc. Id., para. 21 and 22.
Seg Move Tickets were also prepared by SPCSC when AMC or BBS, Inc. instructed it to move book-entry securities between their clearing and safekeeping accounts. While the movement was then entered into SPCSC's records, there was no corresponding change of the account designation made in the records of either SPNTCo. or the Federal Reserve System. Id., para 26.
SPCSC did not place securities, certificated or book-entry, in safekeeping for anyone other than its dealer customers. Viviano Rep., p. 6. The Clearing Agreements permitted AMC and BBS, Inc. to establish within their accounts one or more special accounts for their customers (para. 3(a)). However, at no time were securities in SPCSC's vault actually filed by reference to the name of AMC's or BBS, Inc.'s customers or by any form of sub-account designation of AMC's or BBS, Inc.'s customers. Guardino Aff., para. 17. Seg Move Tickets sometimes recorded the name of AMC's or BBS, Inc.'s customer in a box on the ticket denominated "customer." However, identification of the customer of AMC or BBS, Inc. in this manner depended, in part, on whether this information was included in the instructions transmitted to SPCSC. Id., para. 15. This information was entered on the Seg Move Ticket only for the purpose of assisting AMC or BBS, Inc. with their own record-keeping, and was not used by SPCSC for any purpose. Id.
2. The AMC Test Case Transactions.
As previously noted, transactions involving five securities were designated as test cases in the AMC reorganization proceeding. The securities and the repo and reverse repo participants claiming an interest in them are as follows: *575
Security Reverse Repo Customer Repo Customer
a. GNMA Pool #69692, Merritt Commercial Worthen Bank &
$1,000,000, 12% Savings & Loan Trust Co.
due 8/15/13
b. GNMA Pool #61337, First Savings & Loan First Federal
$1,012,089, 12% of Perth Amboy Savings & Loan
due 8/15/13 of Freeport
c. U.S. Treasury Notes PennBank Champlain
$3,000,000, 11.125% Valley Federal
due 9/30/87 Savings & Loan
d. GNMA Pool #40566, Universal Savings & Worthen Bank &
$1,018,378, 11% Loan Association Trust Co.
due 6/15/10
e. GNMA Pool #57318, First Savings & Loan Lesney Products
$500,000, 11.5% of Perth Amboy
due 2/15/13
Selection of test cases in this proceeding was intended to take into account two factual variables which could potentially affect the legal rights and interests of repo claimants: (1) the location of the subject security as of the filing date of the bankruptcy proceeding (i.e., whether the security was in the AMC clearing or safekeeping account), and (2) whether the subject security was certificated or book-entry in form. The first and second of the above test cases were selected as being representative of AMC transactions involving certificated securities which were located in AMC's clearance account on the filing date of the reorganization proceeding. The third transaction was assigned test case status because it raises common issues relating to delivery or perfection of book-entry securities, portions of which were located in both the clearing and safekeeping accounts of AMC on the filing date. The fourth and fifth of the AMC test cases involve issues arising out of transactions involving certificated securities located in the AMC safekeeping account on the filing date.
In support of his present motion for summary judgment, the AMC Trustee has submitted five affidavits (one for each of the test case transactions) by Henry Green, a consultant retained by the Trustee shortly after his appointment. The Green affidavits recite in narrative fashion the history of each transaction as reflected in the underlying documents collected from the files and records of AMC and produced by Bradford and SPCSC. While the parties who have filed papers in opposition to the Trustee's motion differ as to the importance or significance of particular documents or the language contained in particular documents, they do not contest the essential facts set forth by Mr. Green in his affidavits. Therefore, for purposes of the present motions and cross-motions for summary judgment, the facts summarized below are undisputed. The exhibits cited below refer to the documents annexed to the Green affidavits.
a. GNMA Pool # 69692
On February 25, 1985, AMC entered into a reverse repo transaction with Merritt Commercial Savings & Loan ("Merritt") consisting of AMC's acquisition of the security from Merritt for the sum of $824,000 and a contemporaneous agreement under which Merritt agreed to reacquire the security from AMC on April 17, 1985, for the total sum of $834,156.94. This transaction was reflected in two customer confirmations issued by AMC to Merritt, one denoting Merritt's sale of the security to AMC and the second denoting AMC's agreement to resell the security to Merritt. (Exhibits "A-1" and "A-2"). AMC's agreement to *576 resell was also reflected in a reverse repurchase agreement (Exhibit "B"). Merritt delivered the security to AMC's clearing agent, Bradford, (Exhibits "D" and "E") which maintained it in AMC's account until March 12, 1985, when Bradford delivered the security to SPCSC for AMC's account, in connection with the termination of Bradford's clearing operations and the assumption of all of AMC's clearing services by SPCSC (Exhibit "N").
On March 21, 1985, the security was located in AMC's clearing account at SPCSC. On this date AMC entered into a repo with Worthen consisting of Worthen's acquisition of the security from AMC for the sum of $900,000 and a contemporaneous agreement that AMC would reacquire the security from Worthen on April 12, 1985, for the total sum of $905,060. The transaction was reflected in two customer confirmations issued by AMC to Worthen, denoting AMC's sale to Worthen and Worthen's agreement to resell to AMC, and a repo agreement (Exhibits "T-1," "T-2" and "U").
AMC's confirmation of the sale to Worthen contained delivery instructions indicating that the security was to be held in AMC's safekeeping account at SPCSC. (Exhibit "T-1"). However, no written delivery instructions from AMC to SPCSC directing movement of the security from the clearing account to the safekeeping account have been located among AMC's or SPCSC's records and the security remained in the clearing account until the filing of the Chapter 11 Petition.
b. GNMA Pool # 61337
On October 18, 1984, AMC entered into a reverse repo transaction with First Savings & Loan of Perth Amboy ("Perth Amboy") consisting of AMC's acquisition of the security from Perth Amboy for the sum of $848,000 and a contemporaneous agreement that Perth Amboy would reacquire the security from AMC on November 1, 1984, for the total sum of $851,792.44. This transaction was reflected in two customer confirmations issued by AMC to Perth Amboy denoting the sale to AMC and the agreed upon resale to Perth Amboy, (Exhibits "A-1" and "A-2") and a reverse repurchase agreement (Exhibit "B"). Perth Amboy delivered the security to AMC's clearing account at Bradford (Exhibit "E"). On March 11, 1985, the security was delivered by Bradford to AMC's clearing account at SPCSC in connection with Bradford's termination of clearing operations. (Exhibits "O" and "P").
Upon maturity of the reverse repo, AMC and Perth Amboy extended the term, or "rolled over," the reverse repo. Pursuant to the roll over, Perth Amboy agreed to reacquire the security on May 1, 1985, for the sum of $897,030.89. This transaction was reflected in two customer confirmations issued by AMC (Exhibits "J-1" and "J-2") and a reverse repurchase agreement (Exhibit "K").
On March 20, 1985, the security was located in AMC's clearing account at SPCSC. On that day, AMC entered into a repo with Freeport consisting of Freeport's acquisition of the security for the sum of $950,000 and a contemporaneous agreement by AMC to reacquire the security from Freeport on June 19, 1985, for the total sum of $972,212.95. This transaction was reflected in two customer confirmations issued by AMC to Freeport denoting AMC's sale to Freeport and Freeport's agreement to resell to AMC (Exhibits "Q-1" and "Q-2"), and a repurchase agreement (Exhibit "R").
The confirmation of the sale to Freeport contained delivery instructions to place the security in AMC's safekeeping account at SPCSC. (Exhibit "Q-1"). AMC Issued delivery instructions (DEX) advising SPCSC to move the security into safekeeping (Exhibit "T"). The DEX instruction identified Freeport as the customer to whom the security was sold. Although SPCSC received the instructions, the security was not moved into safekeeping and remained in the clearing account until the filing of the Chapter 11 Petition.
c. U.S. Treasury Notes, 11.125%
On October 17, 1984, AMC entered into a reverse repurchase transaction with PennBank *577 consisting of AMC's acquisition of the Treasury Notes for the sum of $2,756,000 and a contemporaneous agreement by PennBank to reacquire the security on April 15, 1985, for the sum of $2,903,101.50. This transaction was reflected in two customer confirmations issued by AMC to PennBank denoting PennBank's sale and agreement to repurchase, (Exhibits "A-1", "A-2"), and a reverse repurchase agreement (Exhibit "B"). AMC's confirmation of its purchase from PennBank contained delivery instructions advising PennBank to deliver the security to AMC's account at Bradford ("A-1"). PennBank delivered the securities to AMC's clearing account at Bradford on October 17, 1984 through the appropriate book entry wire transfer (Exhibit "E").
On March 18, 1985, AMC entered into a repo with Champlain consisting of Champlain's acquisition of $510,000 of the security for the sum of $531,420 and a contemporaneous agreement by AMC to reacquire the security on May 20, 1985 for the sum of $546,727.85. This transaction was reflected by two customer confirmations issued by AMC to Champlain denoting Champlain's purchase and agreement to resell to AMC, and a written repurchase agreement (Exhibits "I-1," "I-2" and "J").
The customer confirmation of Champlain's purchase contained instructions for AMC to hold the security in safekeeping (Exhibit "I-1"). AMC instructed SPCSC to move $510,000 of the security into safekeeping by DEX instruction dated March 18, 1985, which instruction denominated Champlain as the purchaser (Exhibit "L"). SPCSC accomplished the movement and generated a "Seg Mov ticket" which noted that Champlain was AMC's customer (Exhibit "M").
Through a series of subsequent movements, accomplished by adjustments made by SPCSC without written instructions from AMC, all but $175,000 of the security was transferred out of safekeeping into clearing (Exhibits "Q" through "X").
d. GNMA Pool # 40566
Between June, 1984, and January, 1985, AMC entered into a series of reverse repo transactions with Universal Savings & Loan ("Universal") with respect to the security (Exhibit "A"). When the last of these transactions matured on January 4, 1985, the security was left with AMC and placed in its safekeeping account at Bradford (Exhibits "C" through "G").
On February 25, 1985, AMC entered into another reverse repo transaction with Universal consisting of AMC's acquisition of the security from Universal for the sum of $730,000 and a contemporaneous agreement under which Universal agreed to reacquire the security from AMC on May 28, 1985, for the sum of $747,023.09. The transaction was reflected in two customer confirmations issued by AMC to Universal, denoting Universal's sale to AMC and agreement to repurchase (Exhibits "H-1" and "H-2"), and a reverse repurchase agreement (Exhibit "I"). Delivery to AMC was accomplished by movement of the security from AMC's safekeeping account at Bradford to its clearing account (Exhibits "K", "L" and "M").
On March 11, 1985, Bradford delivered the security to AMC's clearing account at SPCSC in connection with the termination of Bradford's clearing services. (Exhibits "N" and "O").
On March 14, 1985, AMC entered into a repo with Worthen consisting of Worthen's acquisition of the security for the sum of $697,000, and a contemporaneous agreement under which AMC agreed to reacquire the security for the sum of $700,171.35 on April 1, 1985. The transaction was reflected in two customer confirmations issued by AMC to Worthen (Exhibits "Q-1" and "Q-2"), denoting Worthen's purchase agreement to resell to AMC and a repo agreement (Exhibit "R"). The delivery instructions on the confirmation of the sale to Worthen indicated that the security was to be held in safekeeping (Exhibit "P-1").
The security was moved from AMC's clearing account at SPCSC to its safekeeping *578 account on March 14, 1985 (Exhibits "V" and "W"). The delivery instructions (DEX) from AMC to SPCSC directing the movement to safekeeping designated Worthen as the purchaser (Exhibit "T") and SPCSC generated a "seg move ticket" which noted that Worthen was AMC's customer (Exhibit "U").
Upon the maturity of the repo, AMC and Worthen twice extended or "rolled over" the transaction (Exhibits "Y" and "AA"). The second roll over provided for AMC's reacquisition of the security from Worthen on April 16, 1985, in exchange for $788,371.10. The delivery instruction on the confirmation read NO-DEL, indicating that the security was to remain in AMC's safekeeping account (Exhibit "AA-1"). The security was located in AMC's safekeeping account on the date of the Chapter 11 filing. (Exhibit "EE").
e. GNMA Pool # 57318
On October 17, 1984 AMC entered into a reverse repo with Perth Amboy. The transaction consisted of AMC's acquisition of the security for the sum of $283,000 and Perth Amboy's contemporaneous agreement to reacquire the security from AMC on April 15, 1985 for the sum of $298,423.50. The transaction was reflected in two customer confirmations issued by AMC to Perth Amboy, denoting a sale to AMC and the agreed upon sale back to Perth Amboy (Exhibits "A-1" and "A-2"), and a reverse repurchase agreement (Exhibit "B").
The delivery instructions on the customer confirmation of the sale to AMC instructed Perth Amboy to deliver the security to AMC's account at Bradford (Exhibit "A-1"). Bradford received the security into AMC's clearing account on October 17, 1984. (Exhibit "E").
On March 11, 1985, Bradford delivered the security to AMC's clearing account at SPCSC in connection with Bradford's termination of clearing operations (Exhibits "M" and "N"). On March 12, 1985, AMC issued delivery instructions (DEX) to SPCSC to move the security to its safekeeping account (Exhibit "O"). The DEX instructions contained no indication of the AMC customer for whom the security was to be held in safekeeping.
On April 1, 1985, the security was still located in AMC's safekeeping account. On this date AMC entered into the first of three successive repos with Lesney Products with respect to the security. The initial transaction consisted of Lesney's acquisition of the security from AMC for the sum of $447,000 and a contemporaneous agreement by AMC to reacquire the security on April 2, 1985 for the sum of $447,107.09. This transaction was reflected in two customer confirmations issued by AMC to Lesney, denoting Lesney's purchase and agreement to resell (Exhibits "R-1" and "R-2"). No written repo contract has been located among the records of either AMC or Lesney. The internal trade ticket documenting this repo transaction noted that the security was to be held for Lesney in safekeeping.
AMC and Lesney agreed to two extensions, or roll overs, of the original term of the repo, the final extension providing that AMC would reacquire the security on April 8, 1985 for the sum of $445,412.86. Two customer confirmations reflecting this transaction were issued by AMC to Lesney. No written repurchase contract with respect to either of the two roll overs has been located by AMC or Lesney. Each of the customer confirmations issued to Lesney in connection with the original transaction and the roll overs contained the delivery instructions "NO DEL." The security was located in AMC's safekeeping account at SPCSC on the date the Chapter 11 Petition was filed.
3. The BBS, Inc. Test Case Transactions
The BBS, Inc. Trustee seeks summary judgment or partial summary judgment with regard to four of the five test cases set forth in his complaint. The securities and the repo and reverse repo participants involved in these test cases are as follows: *579
Securities Reverse Repo Customer Repo Customer
a. GNMA Pool #47448 Fidelity New York, Champlain Valley
$500,000, 11.5% F.A. Federal Savings
due 4/15/11 & Loan
b. GNMA Pool #63571 Fidelity New York, Worthen Bank
$1,020,000, 11.5% F.A. & Trust Co.,
due 2/15/13 N.A.
c. FHLB, Cusip Mainland Savings Champlain Valley
#313388MX5, & Loan Federal Savings
$2,000,000, 11.2% & Loan
due 1/25/90
d. U.S. Treasury Bills City of Harrisburg Worthen Bank &
$4,300,000, Trust Co., N.A.
due 12/26/85
The first and second test cases were selected as being representative of BBS, Inc. transactions involving certificated securities which were located in the BBS, Inc. safekeeping account on the filing date of the BBS, Inc. liquidation proceeding. The securities involved in the third and fourth test cases are book-entry securities. On the filing date, the FHLB security was recorded as being located in the BBS, Inc. safekeeping account, whereas the Treasury Bills were recorded as being located in its clearance account.
In support of his present motion, the BBS, Inc. Trustee has submitted the affidavit of Roger Landon, in which he sets forth the factual history of each test case transaction gleaned from documents generated by BBS, Inc. and SPCSC. These facts are not in dispute.
a. GNMA Pool # 47448
On May 2, 1984, BBS, Inc. entered into a reverse repo transaction with Fidelity consisting of BBS, Inc.'s acquisition of the security from Fidelity for the sum of $336,000 and a contemporaneous agreement under which Fidelity agreed to reacquire the security from BBS, Inc. on November 1, 1984 for the total sum of $354,361. On November 1, 1984, BBS, Inc. and Fidelity "rolled over" the repo transaction. The roll over provided for the acquisition of the security by BBS, Inc. for the sum of $390,000, which amount was offset by the $336,000 principal amount already paid to Fidelity under the original repo transaction. Fidelity contemporaneously agreed to reacquire the security from BBS, Inc. on May 1, 1985 for the total repurchase price of $411,569.17. The roll over transaction was reflected in two customer confirmations issued by BBS, Inc. to Fidelity, denoting the sale to BBS, Inc. and the agreed upon sale back to Fidelity (Landon Aff., Exhibits 5-6), and a reverse repurchase agreement ( Id., Exhibit 8).
The security was the subject of a repo transaction dated June 1, 1984 between BBS, Inc. and First Federal Savings & Loan of Waterbury. This repo transaction was rolled over several times and was eventually closed out on March 11, 1985 (Landon Aff., para. 16).
On March 29, 1985, BBS, Inc. entered into a repo transaction with Champlain consisting of Champlain's acquisition of the security for the sum of $418,000, and a contemporaneous agreement under which BBS, Inc. agreed to reacquire the security for the total sum of $427,405 on June 27, 1985. The transaction was reflected in two customer confirmations issued by BBS, Inc. to Champlain ( Id., Exhibits 3 and 4), denoting Champlain's purchase and agreement to resell to BBS, Inc. and a repo agreement ( Id., Exhibit 7). The delivery instructions on the confirmation of the sale to Champlain noted that the security was to be held in safekeeping.
*580 In accordance with the delivery instructions listed on the opening confirmation, and on the DEX instructions transmitted by BBS, Inc. to SPCSC ( Id., Exhibit 9), the security was placed in the safekeeping account of BBS, Inc. at SPCSC on March 29, 1985, and remained there as of April 8, 1985 ( See, Id., Exhibits 10 and 11).
b. GNMA Pool # 63571
On February 6, 1984, BBS, Inc. entered into a reverse repo transaction with Fidelity pursuant to which BBS, Inc. acquired the GNMA security for the sum of $800,000 and Fidelity contemporaneously agreed to reacquire the security on a specified future date. The reverse repo transaction was "rolled over" on August 1, 1984. Under the roll over reverse repo transaction, BBS, Inc. acquired the security for the sum of $729,000. Fidelity agreed to repurchase the security on April 26, 1985 for the total sum of $795,046.59. The roll over transaction was reflected in two customer confirmations issued by BBS, Inc. to Fidelity denoting Fidelity's sale and agreement to repurchase ( Id., Exhibits 13 and 14) and a reverse repurchase agreement ( Id., Exhibit 15).
The security was the subject of a repo transaction dated February 29, 1984 between BBS, Inc. and First Federal Savings & Loan Association of Lincoln which was rolled over several times before closing out on February 26, 1985.
On March 7, 1985, BBS, Inc. entered into a repo transaction with Worthen consisting of Worthen's acquisition of the security for $897,000 and a contemporaneous agreement of BBS, Inc. to reacquire the security on April 3, 1985 for the total sum of $903,222.93. Two customer confirmations denoting Worthen's purchase and agreement to resell ( Id., Exhibits 16 and 17) and a repurchase agreement ( Id., Exhibit 18) were generated by BBS, Inc. In accordance with the delivery instructions on the opening confirmation and the DEX instructions transmitted to SPCSC ( Id., Exhibit 19), the security was received into the BBS, Inc. safekeeping account at SPCSC on March 7, 1985 ( see Id., Exhibit 20).
BBS, Inc. and Worthen agreed to roll over the repo transaction on April 3, 1985. This renewal of the repo transaction was also reflected in two customer confirmations ( id., Exhibits 22 and 23) denoting Worthen's acquisition of the security for $895,000 and the contemporaneous agreement by BBS, Inc. to repurchase the security on April 10, 1985 for the total sum of $896,522.74. The delivery instructions on the opening confirmation read "no delivery," indicating that the security was to remain in the BBS, Inc. safekeeping account, where it was located on the filing date of this liquidation proceeding ( see, id., Exhibit 24).
c. FHLB, Cusip # 31388MX5
On February 20, 1985, BBS, Inc. entered into a reverse repo transaction with Mainland Savings & Loan ("Mainland"). The original transaction was followed by a series of roll overs, the last of which occurred on April 3, 1985. The final roll over was reflected in two customer confirmations ( id., Exhibits 27 and 28) denoting the acquisition of the securities by BBS, Inc. for $1,880,000 and the contemporaneous agreement of Mainland to reacquire the securities on April 17, 1985 for the total sum of $1,886,397.22. BBS, Inc. also generated a standard reverse repurchase agreement with regard to this last roll over ( id., Exhibit 29).
During the course of the series of reverse repurchase transactions with Mainland, BBS, Inc. entered into several repo transactions with respect to varying amounts of the FHLB securities. One amount having a par value of $930,000, was substituted by BBS, Inc. for Treasury Bills which were the subject of a repo transaction between BBS, Inc. and the City of Austin dated January 9, 1985 pursuant to which the City of Austin paid BBS, Inc. the sum of $927,000 and BBS, Inc. contemporaneously agreed to reacquire the securities on June 28, 1985 for the total sum of $963,420.80. ( See, id., Exhibits 30 and 31). *581 In accordance with the delivery instructions on the opening confirmation of this repo transaction and the DEX instructions transmitted to SPCSC by BBS, Inc. ( Id., Exhibit 32), the $930,000 amount of the FHLB securities was delivered to the City of Austin against payment of the $927,000 purchase price on February 27, 1985, and apparently was liquidated by the City of Austin on or after the filing date of this proceeding.
Another amount of the FHLB securities, having a principal value of $280,000, was the subject of a repo transaction entered between BBS, Inc. and Champlain on March 29, 1985. Two customer confirmations were issued by BBS, Inc. to Champlain ( id., Exhibits 34 and 35) reflecting Champlain's initial purchase of the FHLB securities for $289,000 and BBS, Inc.'s contemporaneous agreement to repurchase the securities on June 27, 1985 for the total sum of $295,502.50. A repurchase agreement was also generated by BBS, Inc. ( id., Exhibit 36). The delivery instructions on the opening confirmation and the DEX instructions note that the securities were to be delivered into safekeeping, and in fact were recorded as being held in the BBS, Inc. safekeeping account as of April 8, 1985 ( see, id., Exhibit 38).
d. U.S. Treasury Bills, Cusip # 912794HQO
The City of Harrisburg initially purchased the U.S. Treasury Bills from BBS, Inc. in two positions. The first position having a value at maturity of $3,200,000 was purchased for $2,933,648 on January 2, 1985. The second position, having a value at maturity of $1,100,000, was purchased for $1,018,032.88 on January 28, 1985. BBS, Inc. entered into reverse repo transactions with Harrisburg with respect to these positions on January 4 and January 29, 1985, respectively. BBS, Inc. and Harrisburg twice "rolled over" the reverse repo transactions. The second roll over provided for the purchase of the two positions by BBS, Inc. for $2,964,000 and $1,018,000, and Harrisburg contemporaneously agreed to reacquire on May 15, 1985 the first position for the total sum of $2,998,580 and the second position for $1,029,867.67. This final roll over was memorialized in four confirmations (two for each position) ( id., Exhibits 44, 45, 46 and 47) and two separate reverse repurchase agreements ( id., Exhibits 48 and 49).
BBS, Inc. entered into a number of repo transactions involving varying amounts of the U.S. Treasury Bills subsequent to the entry of the reverse repo transactions with Harrisburg. One amount, having a value at maturity of $870,000, was the subject of a repo transaction between Dominion Bank, N.A. ("Dominion") and BBS, Inc. entered on February 20, 1985 and scheduled to close on May 21, 1985. Another amount of the Treasury Bills, having a value at maturity of $580,000, was substituted on February 25, 1985 for another security which was the subject of a repo transaction between BBS, Inc. and the County of Dauphin, Pennsylvania ("Dauphin") dated January 16, 1985. The repo transaction between BBS, Inc. and Dauphin was rolled over on February 27, 1985 and was scheduled to close on April 19, 1985. A third amount of the Treasury Bills, having a value at maturity of $700,000, was the subject of a repo transaction between BBS, Inc. and Hamilton Bank ("Hamilton") which was opened on April 4, 1985 and was scheduled to close on May 6, 1985. Dominion, Dauphin and Hamilton each took possession of the amounts of the Treasury Bills involved in their respective repo transactions with BBS, Inc., and subsequent to the filing date of the within liquidation proceeding, they each liquidated the Treasury Bills in their possession.
A fourth block of Treasury Bills having a value at maturity of $1,440,000 was the subject of a repo transaction between BBS, Inc. and Worthen on April 4, 1985. Two customer confirmations were issued by BBS, Inc. to Worthen ( id., Exhibits 70 and 71) reflecting Worthen's initial purchase of the Treasury Bills for $1,346,000 and BBS, Inc.'s contemporaneous agreement to repurchase the securities on April 11, 1985 for the total sum of $1,348,316.24.
*582 On April 4, 1985, BBS, Inc. instructed SPCSC to move the securities from its clearing account to its safekeeping account ( id., Exhibit 72). However, as of April 8, 1985, $1,450,000 of the original amount of Treasury Bills remained in the BBS, Inc. clearing account.
The remaining $700,000 of the $4,300,000 of the Treasury Bills which were the subject of the reverse repo transactions between BBS, Inc. and Harrisburg was used by BBS, Inc. to satisfy margin requirements of institutions of which BBS, Inc. was a customer.
IV. ISSUES
The object of the pending motions and cross-motions for summary judgment is to determine whether the securities underlying the test case repo and reverse repo transactions (or the proceeds of the sale thereof) are property of the AMC or BBS, Inc. estates or belong instead to the repo participants or reverse repo participants. The property interests of the respective parties are critically affected by resolution of the question whether repo and reverse repo transactions are properly characterized as purchase-and-sale transactions or secured loan transactions. That is to say, are they transactions involving an initial contract for the sale (or purchase) of securities, subject to a simultaneously executed contract for their repurchase (or resale) at an agreed date, or are they secured loan transactions pursuant to which the securities served as collateral for the repayment of the original loan amount on an agreed date at an agreed rate of interest? A number of subsidiary issues are necessarily dependent upon the determination of the legal status of repo and reverse repo transactions.
If repo and reverse repo transactions are purchases and sales, then a determination must be made as to whether the repo participants (a) took delivery of the securities pursuant to § 8-313(1) of the Uniform Commercial Code of New Jersey, N.J.S.A. 12A:8-313(1) ("the N.J.U.C.C.") or received transfer of the securities under § 8-313(1) of the Uniform Commercial Code of New York, N.Y. Consolidated Laws, Uniform Commercial Code § 8-313 (McKinney Supp. 1986) ("the N.Y.U.C.C."), and/or (b) attained the status of bona fide purchasers pursuant to § 8-301(2) of the N.J.U.C.C. or § 8-302(3) of the N.Y.U.C.C. If repo participants did not take delivery or receive transfer of the securities and are not bona fide purchasers, then a further determination must be made as to whether the reverse repo agreements are "executory" contracts within the meaning of 11 U.S.C. § 365 , and can therefore be rejected by the Trustees if deemed burdensome to the estates.
If repo and reverse repo transactions are secured loans, then a determination must be made as to whether the repo participants perfected a security interest in the securities pursuant to § 9-305 of the N.J.U.C.C. or § 8-321(2) of the N.Y.U.C.C. If the repo participants did not perfect security interests in the securities (and are not bona fide purchasers of the securities), then a further determination must be made as to whether reverse repo participants should be equitably estopped from exercising their rights to reclaim the securities pledged as collateral for their loans from AMC or BBS, Inc.
Lastly, the motions and cross-motions filed in the BBS, Inc. adversary proceeding raise the issue of whether repo and reverse repo participants were "customers" of BBS, Inc. within the meaning of 15 U.S.C. § 78111 (2).
V. DISCUSSION
In order to prevail on a motion for summary judgment, the moving party must establish that "there is no genuine issue as to any material fact and that (it) is entitled to a judgment as a matter of law." Fed.R. Civ.P. 56(c). Once the moving party has carried its burden under Rule 56, "its opponent must do more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Electric Industrial Co., Ltd. v. Zenith Radio Corp., ___ U.S. ___, ___, 106 S.Ct. 1348, 1356 , 89 *583 L.Ed.2d 538, 552 (1986), rev'g. 723 F.2d 238 (3d Cir.1983). The opposing party must set forth specific facts showing a genuine issue for trial and may not rest upon the mere allegations or denials of its pleadings. Delong Corp. v. Raymond International, Inc., 622 F.2d 1135, 1139 (3d Cir.1980). The Supreme Court recently explained that in evaluating the evidence presented, "(w)here the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no `genuine issue for trial.'" Matsushita, ___ U.S. at ___, 106 S.Ct. at 1356 , 89 L.Ed.2d at 552 .
When considering a motion for summary judgment, all evidence submitted must be viewed in a light most favorable to the party opposing the motion. Wahl v. Rexnord, 624 F.2d 1169, 1181 (3d Cir.1980). As I noted in Brown v. Hilton, 492 F.Supp. 771, 774 (D.N.J.1980):
[A] court is required to resolve all ambiguities and draw all inferences in favor of the party against whom summary judgment is sought. Furthermore, even when the material facts are not in dispute, summary judgment may be inappropriate when contradictory inferences may be drawn from the facts.
However, in non-jury cases such as the present adversary proceedings, it is entirely appropriate for the court, as the ultimate finder of fact, to resolve competing factual inferences that may reasonably be drawn from the evidence on summary judgment if a full evidentiary hearing or trial would not enhance the court's ability to draw such inferences and conclusions of fact. Nunez v. Superior Oil Co., 572 F.2d 1119, 1123-24 (5th Cir.1978); United States v. ACB Sales & Services, Inc., 590 F.Supp. 561, 569 (D.Ariz.1984). As stated in the ACB Sales case:
The propriety of summary judgment in a nonjury case should rest less upon the at times purely semantic distinction between questions of law and fact and more upon the question of whether a full evidentiary hearing would serve any real purpose. If the underlying evidentiary facts are undisputed and, thus, full trial would serve only the purpose of supplanting affidavits and transcripts with live testimony, then resolving the ultimate factual issue in a motion for summary judgment is appropriate.
Id. at 569 .
In the present test cases, the factual record is voluminous and exhaustive. As previously noted, the documentary evidence reflecting the repo and reverse repo transactions at issue is uncontroverted. The principal dispute between the parties to the present motions and cross-motions revolves around the legal significance and consequences of material facts which are not in dispute. To the extent that undisputed material facts give rise to conflicting factual inferences (which customarily should be resolved in favor of the party opposing summary judgment), the record in the present proceedings is sufficiently well-developed to warrant a determination on summary judgment of any such disputed factual inferences.
The record includes the reports, affidavits and/or transcripts of deposition testimony of various experts which set forth conflicting opinions as to (1) the economic or financial significance of repo and reverse repo transactions and (2) the social and economic significance of certain legal determinations which particular parties are advocating in the present motions and cross-motions. Live testimony by these same experts at a full evidentiary hearing or trial would be largely duplicative and superfluous. Such live testimony would not significantly contribute to the already extensive factual record nor appreciably enhance the court's ability to draw its own inferences and conclusions from undisputed material facts. Delaying drawing such inferences and conclusions until after a full evidentiary hearing or trial would therefore unnecessarily prolong these proceedings and add to the expense of the bankrupt estates and their creditors, a result which would be inimical to the policy of economy of administration in bankruptcy cases.
Furthermore, there are factual disputes as to certain attributes of the repo and *584 reverse repo transactions which are the subject of the present motions and cross-motions. For example, the parties disagree as to the size of the "haircuts" in the original purchase prices of the underlying securities and the transfer costs associated with actual delivery of securities in possessory repo transactions. However, these facts, and others in dispute are not material, insofar as the resolution of such factual issues would not affect the outcome of the motions and cross-motions. The same conclusions of law would be reached regardless of how these factual disputes are ultimately resolved.
A. Legal Characterization of Repo and Reverse Repo Transactions.
1. Contentions of the Parties
The AMC and BBS, Inc. Trustees have adopted opposing views as to the legal characterization of repo and reverse repo transactions. The AMC Trustee regards the characterization of such transactions as a straight-forward matter of contract interpretation. He argues that the determination as to whether repo and reverse repo agreements are contracts of purchase and sale or secured loan agreements should be governed by the intent of the parties to these agreements, as reflected in the transaction documents. The AMC Trustee asserts that the language employed in the documents memorializing the transactions clearly and unambiguously reflects an intention to purchase and sell the underlying securities.
The AMC Trustee further argues that it is neither required nor appropriate to look beyond the language of the written instruments if this language leaves no doubt as to its meaning. Nevertheless, he contends that extrinsic evidence relating to the situation of the parties and the circumstances of the agreements, as well as important public policy considerations and applicable decisional law, support a conclusion that repo and reverse repo transactions are purchases and sales as a matter of law. In particular, the AMC Trustee asserts that, as a matter of custom and usage in the securities industry, reverse repo participants relinquish all control over or legal interest in the securities during the term of the reverse repo agreement. This fact, the AMC Trustee contends, is wholly inconsistent with a secured loan characterization.
The Repo Committee and the FRBNY concur in the conclusion of the AMC Trustee that repo and reverse repo transactions, properly characterized, are contracts of purchase and sale. The FRBNY focuses on certain public policy considerations which it argues militate in favor of a purchase and sale characterization. In particular, the FRBNY asserts that the continued efficient functioning of the government securities markets depends on the liquidity and flexibility afforded investors by repo and reverse repo transactions. According to the FRBNY, structuring such transactions as purchases and sales serves two essential functions: (1) securities delivered under repo agreements remain freely transferable and unencumbered by restrictions from previous transfers, and (2) the Federal Reserve and other public entities which are subject to statutory or regulatory restrictions or prohibitions against lending and/or borrowing remain free to participate in the repurchase market.
The BBS, Inc. Trustee argues that the economic substance and not the form of the transactions at issue should govern the determination of the legal characterization of repo and reverse repo transactions. When viewed from this perspective, he contends that the transactions lack two critical elements of a true sale. First, according to the BBS, Inc. Trustee, there is no shift from the seller/borrower to the purchaser/lender of the risk associated with a potential decrease in the value of the underlying securities or of the expectation of benefit from any gain in the value of the securities. Any decline or appreciation in the value of the securities remains the loss or gain of the seller/borrower. Second, the BBS, Inc. Trustee asserts that the economic return on the securities, including interest (or, in the case of GNMA securities, *585 principal and interest) paid on the securities, remains with the seller/borrower.
The BBS, Inc. Trustee further cites a number of characteristics of the test case repo and reverse repo transactions which are typically associated with secured loans:
(1) The dealers and their counterparties priced the original transaction amount below the market value of the securities, thus providing an initial "haircut" or "cushion" for the benefit of the lender;
(2) The resale price was arrived at by adding to the original principal amount interest calculated at a fixed rate for the term of the transaction;
(3) The interest rate was negotiated at a rate which had no relationship to the interest rate of the underlying securities;
(4) In certain reverse repo transactions, the purchaser/lender (i.e., AMC or BBS, Inc.) had the right to "mark-to-market," that is, could demand additional security (margin) in the event of a decline in the market value of the underlying securities;
(5) In repo transactions, the seller/borrower (i.e., AMC or BBS, Inc.) customarily reserved the right to substitute securities;
(6) The obligation to resell or repurchase the securities was to take effect on a fixed maturity date; and
(7) Upon a failure of the seller/borrower (either AMC or BBS, Inc. in repo transactions or a reverse repo participant in reverse repo transactions) to repurchase the securities, the buyer/lender was entitled to sell the securities without notice, and was permitted to charge any loss to the seller/borrower.
The Reverse Repo Committee, SIPC, Fidelity and Prudential support the secured loan characterization advanced by the BBS, Inc. Trustee.
2. Applicable Law
The parties uniformly agree that the determination of the legal character of repo and reverse repo transactions and their respective property rights in the underlying securities is governed by state law. Section 541(a) of the Code provides that the debtor's estate includes all legal and equitable interests of the debtor in property, wherever located, or by whomever held, as of the commencement of the bankruptcy proceeding. 11 U.S.C. § 541 (a). As stated in 4 Collier on Bankruptcy, ś 541.02(1) (15th Ed.):
Section 541 of the Code . . . provides a system for dealing with the debtor's interest in property and his debts. However, the existence and nature of the debtor's interest in property . . . are determined by non-bankruptcy law.
The Supreme Court in Butner v. United States, 440 U.S. 48, 54 , 99 S.Ct. 914, 917 , 59 L.Ed.2d 136 (1979) confirmed that "Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law." The Court further described the rationale for looking to state law for the determination of property rights:
Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests in both state and federal courts within a state serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving `a windfall merely by reason of the happenstance of bankruptcy.' Lewis v. Manufacturers National Bank, 364 U.S. 603, 609 [ 81 S.Ct. 347, 350 , 5 L.Ed.2d 323 (1961)]. The justifications for application of state law are not limited to ownership interests; they apply with equal force to security interests, including the interests of a mortgagee in rents earned by mortgaged property.
Id. at 55, 99 S.Ct. at 918 .
The parties to the present motions and cross-motions argue that either the substantive law of New Jersey or New York should govern the legal characterization of repo and reverse repo transactions. In particular, *586 the Reverse Repo Committee flatly asserts that the determination of whether the test case transactions constitute a transfer of a security interest or the outright sale of securities is governed by Article 9 of the N.J.U.C.C., which applies to secured transactions. Such an argument, however, assumes the conclusion. As the Third Circuit noted in Major's Furniture Mart v. Castle Credit Corp., 602 F.2d 538 , 542-43 (3d Cir.1979):
[W]hile the [U.C.C.] instructs us as to the consequences that ensue as a result of the determination of "secured indebtedness" as contrasted with "sale," the [U.C.C.] does not provide assistance in distinguishing between the character of such transactions. This determination, as to whether a particular assignment constitutes a sale or a transfer for security, is left to the courts for decision.
Such a determination therefore is made by reference to the common law of the appropriate state. The Reverse Repo Committee also contends that the economic substance of repo and reverse repo transactions is the only factor a court should consider. Neither the common law of New Jersey nor of New York support such a categorical assertion.
Under both New Jersey and New York law, contracts such as the repo and reverse repo agreements at issue here must be construed in accordance with the probable common intent of the parties. See, e.g., Kearny PBA Local No. 21 v. Town of Kearny, 81 N.J. 208, 221 , 405 A.2d 393 (1979); Madawick Contracting Co. v. Travelers Insurance Co., 307 N.Y. 111, 119 , 120 N.E.2d 520 (1954). Where the intention of the parties is clearly and unambiguously set forth in the agreement, effect must be given to the parties' intent as revealed in the language used without regard to extrinsic evidence. See, e.g., Midland Carpet Corp. v. Franklin Associated Properties, 90 N.J.Super. 42, 46 , 216 A.2d 231 (A.D.1966); West, Weir & Bartel, Inc. v. Mary Carter Paint Co., 25 N.Y.2d 535 , 307 N.Y.S.2d 449, 451-52 , 255 N.E.2d 709, 711-12 (1969). The objective intent of the parties expressed or apparent in the writing controls the interpretation of a contract. Friedman v. Tappan Development Corp., 22 N.J. 523, 531 , 126 A.2d 646 (1956); Hartford Accident & Indemnity Co. v. Wesolowski, 33 N.Y.2d 169, 171 , 350 N.Y.S.2d 895 , 305 N.E.2d 90 (1973). The undisclosed, subjective intent of the parties has no bearing on contract construction. Krosnowski v. Krosnowski, 22 N.J. 376, 386 , 126 A.2d 182 (1956); In re Smith's Will, 254 N.Y. 283, 289 , 172 N.E. 499 (1930). Furthermore, the words and phrases utilized in an agreement should be given their ordinary and familiar meaning. See, e.g., Independent Oil Workers at Paulsboro, N.J. v. Mobil Oil Corp., 441 F.2d 651, 653 (3d Cir.1971); Laba v. Carey, 29 N.Y.2d 302, 308 , 327 N.Y.S.2d 613 , 277 N.E.2d 641 (1971)
However, under both New York and New Jersey law, isolated words and phrases are not necessarily determinative of the meaning of the agreement, even if the meaning of these particular words and phrases is not subject to differing interpretation. As the New Jersey Supreme Court stated in Krosnowski :
A contract must be construed as a whole and the intention of the parties is to be collected from the entire instrument and not from detached portions. Individual clauses and particular words must be considered in connection with the rest of the agreement . . .
22 N.J. at 387, 126 A.2d 182 ; see also, Indovision Enterprizes, Inc. v. Cardinal Export Corporation, 44 A.D.2d 228 , 354 N.Y.S.2d 113, 115 (A.D. 1st Dept. 1974). In Newark Publishers' Assn. v. Newark Typographical Union, 22 N.J. 419, 427 , 126 A.2d 348 (1956), the Court further specified:
Disproportionate emphasis upon a word or clause or a single provision does not serve the purpose of interpretation. Words and phrases are not to be isolated but related to the context and the contractual scheme as a whole, and given the meaning that comports with the probable intent and purpose; and thus the *587 literal sense of terms may be qualified by the context.
See also, Empire Properties Corporation v. Manufacturers Trust Co., 288 N.Y. 242 , 43 N.E.2d 25, 28 (1942).
In those cases where the express terms of an agreement are ambiguous, conflicting or unclear, and the intended meaning and operation of the contract can not reasonably be derived from the four corners of the writing, New Jersey and New York courts alike allow the introduction and examination of extrinsic evidence of intent as an aid in interpretation. Bedrock Foundations, Inc. v. Geo. H. Brewster & Son, Inc., 31 N.J. 124, 133 , 155 A.2d 536 (1959); 67 Wall Street Co. v. Franklin National Bank, 37 N.Y.2d 245, 248-49 , 371 N.Y.S.2d 915 , 333 N.E.2d 184 (1975). In such cases, courts must necessarily consider "the relations of the parties, the attendant circumstances, and the objects they were trying to attain." Tessmar v. Grosner, 23 N.J. 193, 201 , 128 A.2d 467 (1957); see also, Mister Filters v. Weber Environmental Systems, 44 A.D.2d 639 , 353 N.Y.S.2d 835, 837 (A.D. 3d Dept. 1974). Among other extrinsic factors, New Jersey and New York courts have variously taken into account trade practices, and customs and meanings, Ace Stone, Inc. v. Wayne Township, 47 N.J. 431, 439 , 221 A.2d 515 (1966); Mister Filters, supra, at 837 and subsequent conduct of the parties in performance of the agreement, Michaels v. Brookchester, Inc., 26 N.J. 379 , 388 and 390, 140 A.2d 199 (1958); Studley v. National Fuel Gas Supply Corp., 485 N.Y.S.2d 880, 884 (A.D. 4th Dept. 1985).
3. Express Terms of Repo and Reverse Repo Transactions.
The express purchase and sale language contained in the repo and reverse repo agreements and the two confirmation slips issued by BBS, Inc. and AMC to its repo and reverse repo customers is described in the factual background portion of this opinion and need not be repeated here. The plain meaning of these terms can not seriously be disputed. Viewed in isolation, such terms reflect the objective intent of the parties to engage in purchase and sale transactions, and, absent other language in the transaction documents evidencing a contrary intent, the test case repo and reverse repo transactions would be given legal effect as such under New York and New Jersey law without reference to extrinsic evidence of intent.
While the transaction documents do not explicitly refer to the pledge of collateral securing a debt or other terms of art customarily found in security agreements or loan or pledge instruments, the BBS, Inc. Trustee and the Reverse Repo Committee argue that there is other language which casts doubt on whether the parties intended to engage in purchase and sale or secured loan transactions. [2] In particular, they note that the transaction documents contain terms normally found in credit transactions which are inconsistent with a purchase and sale construction.
First, the repurchase price designated in the repo and reverse repo agreements is the sum of the original "purchase price" or principal loan amount plus interest on that amount calculated at a fixed rate through the date of repurchase. The interest rate is a market rate that bears no relation to the interest rate of the underlying security. The payment of interest on principal and the existence of a maturity date are characteristics typically associated with loan transactions. However, the same characteristics are also present in other transactions which unquestionably involve the purchase and sale of securities. For example, the yield on investments in Treasury securities (which are widely characterized as government debt obligations) is based on a fixed market rate of interest payable up to *588 a predetermined maturity date, at which time the principal amount of the securities is redeemable by the holder of the securities. Yet the acquisition of such securities on the retail market is universally recognized as a purchase through which investors attain a freely transferable ownership interest. Certainly, the mere calculation of the yield on an investment by reference to a fixed rate of interest payable up to a date certain is not necessarily inconsistent with a purchase and sale.
Second, on the maturity of the repo or reverse repo transaction, the buyer/lender must return the same underlying security to the seller/borrower in exchange for the repurchase amount. Meiselman Rep. at 4 ("buyer/lender must return the same securities . . . and may not substitute a different security even if it is of equivalent value"). The Repo Committee and the FRBNY disagree with this contention and argue that the obligation to resell requires only the return of similar or equivalent securities of the same class, issue and value. See, e.g., Goldman Rep. at 28; Pugh Rep. at 4; Pugh Dep. at 81-84 (during which he qualified but did not abandon his position that the return of equivalent securities is permissible under repo and reverse repo transactions).
Even assuming that the agreements require the return of identical securities, it is unclear why the Reverse Repo Committee believes this fact distinguishes repo and reverse repo transactions as secured loans. Indeed, under § 9-207(2)(d) of the U.C.C. a secured party is allowed to commingle fungible collateral, including certain types of securities, and may sell the collateral and replace it with instruments which are equivalent in kind and value without breaching his duty to exercise reasonable care in the custody and preservation of the pledged collateral. See N.J.S.A. 12A:9-207(2)(d); N.J.S.A. 12A:1-201(17) (securities are "fungible" if they are, "by nature or usage of trade, the equivalent of any other like unit"); Fedders Corp. v. Taylor, 473 F.Supp. 961, 974 (D.Minn.1979).
Third, upon the failure of the seller/buyer to repurchase the securities on the maturity date of a repo or reverse repo transaction, the buyer/lender may sell the securities without notice and for the best price possible. This term in the repo and reverse repo agreements also does not provide a factual basis for favoring a secured loan characterization over a purchase and sale characterization. Rather, this language merely sets forth the legal consequences of both a breach of a purchase and sale contract whereby the seller is released from his obligation to sell and is correspondingly entitled to dispose of the contracted goods in a commercially reasonable manner upon reasonable notice to the breaching buyer, see, e.g., N.J.S.A. 12A:2-706, as well as a default on a loan secured by pledged collateral whereby the secured creditor is similarly entitled to dispose of the collateral upon notice to the defaulting debtor. N.J.S.A. 12A:9-504. The "without notice" phrase is equally ineffective under either characterization.
Fourth, the seller/borrower retains coupon interest. The BBS, Inc. Trustee and the Reverse Repo Committee point to this term as evidence that one critical indicia of ownership, i.e., the economic return on the securities, did not pass to the purported "buyers" as would customarily occur in a true sale. The Repo Committee contends that this provision is not applicable to the test case repo and reverse repo transactions because the securities involved in these transactions did not bear interest coupons. Such a narrow reading of this provision is entirely inappropriate. Those experts who have expressed an opinion on the scope of this provision, including the expert retained by the Repo Committee, have agreed that it applies equally to "pass through" payments of interest and principal (with respect to GNMA securities) and to fixed amounts of interest paid every six months on other securities. Landon Aff. ś 8; Goldman Dep., pp. 169-70, 173-74; Geiger Dep., pp. 102-04. Furthermore, in the four AMC reverse repo transactions involving GNMA securities, the reverse repo participants, and not AMC or the repo *589 participants, received principal and interest payments on the underlying securities until AMC filed for bankruptcy. Bryan E. Green Aff., ś 7(g); Johnson Aff., ś 7(g); Morris Aff., ś 7(f); Mulligan Aff., ś 7(g). There is no question that retention of principal and/or interest payments by a seller/borrower is a common feature of collateralized loans. See N.J.S.A. 12A:9-207(2)(c) (profits derived from pledged collateral in the form of money must either be remitted to debtor or applied to reduce the secured obligation).
Fifth, in reverse repo agreements only, the purchaser/lender is given the right to request additional margin any time during the life of the agreement. As in a typical collateralized loan, this "mark-to-market" provision entitled AMC or BBS, Inc. to request additional collateral from reverse repo participants in order to maintain an adequate level or margin in the event the underlying securities decline in value. The BBS, Inc. Trustee and the Reverse Repo Committee contend that this provision demonstrates that the seller/borrower continues to bear the risks relating to market fluctuations despite the purported "sale" of the securities.
Lastly, under the express terms of repo agreements only, AMC and BBS, Inc. had the "right of substitution." The meaning and scope of this right are matters of considerable factual dispute between the parties. The parties agree that a right of substitution permits the seller/borrower to replace the securities underlying a repo transaction with alternative securities. They disagree, however, as to whether this right is exercisable in possessory and non-possessory (custody) repo transactions alike and whether replacement of the underlying securities is limited to securities of the same issue.
Clifford Goldman, the expert retained by the Repo Committee, emphasized in his report and deposition testimony that dealers reserve a right to substitute securities in order to maintain control over their securities inventories and thereby retain the flexibility they require to effectively and efficiently operate in the repo market. Goldman Rep. at 26; Goldman Dep. at 220. These same concerns would not extend to securities delivered to repo participants in possessory repo transactions. Furthermore, as will be discussed below in greater depth, an essential element of repo and reverse repo transactions is the free transferability of the underlying securities. As the Second Circuit noted in SEC v. Drysdale, 785 F.2d 38 , 41 (2d Cir.1986), the purchaser/lenders in repo and reverse repo transactions are free to "trade, sell or pledge" the securities. If the dealer's right of substitution is construed to apply to securities transferred in possessory repo transactions, then the ability of the repo participant to exercise his right to deal in the securities would be compromised.
The Repo Committee contends that the right of substitution is limited to securities of the same issue, class and maturity and in the same face amount as the original securities. In support of this contention, the Committee relies, in part, on SEC v. Miller, 495 F.Supp. 465 (S.D.N.Y.1980), in which the court interpreted the right of substitution to mean that a dealer "may substitute different securities of the same issue." This interpretation, however, does not square with the record in these adversary proceedings. Several industry experts have stated in their reports that the right of substitution extends to securities of like kind or quality and of equal or greater value. Stigum Rep., pp. 72, 84-85; Goldman Rep., pp. 4, 25-26. Indeed, in one of its repo transactions with Champlain, BBS, Inc. substituted two GNMA securities and two securities issued by the Federal Home Loan Mortgage Corp. for one GNMA security. King Aff., 4/21/85, śś 12-15. Mr. Goldman acknowledged in his deposition testimony that the right of substitution is important to dealers, in part, because it gives them the continuing ability to respond to market fluctuations in the value of securities they are carrying in inventory, including securities sold to repo participants in non-possessory repo transactions. Goldman Dep., pp. 220-221. However, a dealer's ability to capture market *590 appreciation or minimize market losses on securities which increase or decrease in value during the term of a non-possessory repo transaction would be effectively undermined if substitution were limited to securities of the same class, issue, maturity and value. The record in these test cases supports a conclusion that the express right of substitution contained in the Repo Agreements entitled AMC and BBS, Inc. to substitute securities of equivalent value and quality for securities over which they retained possession or control during the term of custody repo transactions. The BBS, Inc. Trustee and the Reverse Repo Committee note that any such right of substitution customarily would not be present in an outright purchase and sale of securities.
As the preceding discussion reveals, repo and reverse repo agreements contain terms which are not typically found in the outright purchase and sale of securities. The reality, of course, is that repo and reverse repo transactions are not straight-forward purchase and sale transactions, and no party to the present motions and cross-motions contends that they are. In the usual one-way purchase and sale of securities, the seller's interest in the underlying securities is extinguished upon the transfer of the securities against payment. In repo and reverse repo transactions, however, the seller of the securities contemporaneously agrees to reacquire the securities on a specified future date. The parties to repo and reverse repo transactions therefore remain subject to market and credit risks which are not present in one-way purchase and sale transactions. The seller necessarily retains an interest in what happens to the value of the securities he is contractually obligated to reacquire. To the extent that the buyer continues to trade in the securities prior to the repurchase date, he remains subject to market fluctuations in their value. In addition, as in any purchase and sale contract, the original buyer is subject to the risk that the counter-party (the original seller) will fail to perform on his obligation to repurchase the securities, and is further subject to the market risk that the value of the securities will have decreased in the interim to below the agreed repurchase price.
In order to protect themselves against the additional market and credit risks associated with repo and reverse repo transactions, dealers such as AMC and BBS, Inc., in particular, have negotiated terms to the repo and reverse repo agreements which are typically found in secured loan transactions. Certain of these terms are not uniformly applied to both repo and reverse repo transactions. For example, the right of substitution was only extended to AMC and BBS, Inc., as sellers in repo transactions and provided them with some protection against the risk of market fluctuations in the value of the underlying securities prior to the date they were obligated t

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/1543384. Public record. Not legal advice.