Good Faith Purchase of Stolen Goods
Traditional legal principles are seemingly pretty clear and straightforward on how a good faith acquisition of stolen goods is to be treated: the buyer, even though he is not criminally liable, can not acquire title to stolen property. Title remains with the original owner and the buyer who has acquired such property in good faith only has recourse to the party that sold the goods to him.
While this principle is not applied in all jurisdictions – in some places the good faith purchaser has been favored (for instance in Sweden until 2003, when the law was changed) – it has been an integral part of the Western legal tradition since antiquity. Therefore, even though we are not lawyers, we can state with some confidence that it is recognized by most Western courts.
In J.E. Penner's 2001 edition of Mozley and Whiteley's Law Dictionary, 12th Ed., Butterworths, London, we find the following quote on page 280:
“If a chattel is stolen, the thief acquires no title, and in accordance with the maxim nemo dat quod non habet (one cannot give what one does not have), cannot give good title to a buyer from him, even if the buyer is innocent of knowledge that the property was stolen”
The principle of 'nemo dat quod non habet' indeed stems from Roman law, so this particular feature of property rights represents what we like to refer to as a 'traditional legal principle' – a feature of the law that has been with us for a very long time and has been contested or altered only rarely.
However, certain exceptions to the rule do exist and they vary from country to country. Bona fide purchase rules are recognized in many countries in parallel with the 'nemo dat' principle, often in conjunction with a statute of limitation.
There is usually also a differentiation between stolen and 'misappropriated' goods. The difference between stolen and misappropriated goods is the following: if A is the original owner and B is a thief who sells the goods to C after having committed theft, then B never had title to the goods and they are considered stolen.
However, a case is imaginable in which B did in fact have title or the legal right to dispose of the goods concerned, for instance by dint of being a trustee for A.
In this case, the goods are considered 'misappropriated' if B sells them to C against A's wishes.
In Germany, a good faith buyer of mishandled goods does acquire title to the property, but if the original owner claims them back within ten years, the good faith buyer's title is forfeited. In France a similar rule applies, except the statute of limitation is shorter – it is only three years. Also, the original owner has to pay a redemption fee to the bona fide purchaser, if the goods were purchased at an auction, on an open market, or a similar setting.
In Anglo-Saxon law, the 'nemo dat' principle is applied very strictly. In the UK, a slight exception is made with regards to goods bought at 'market overt', this is to say a market where the sale of such goods is conducted openly (this is similar to the French rule on goods bought at auction or similar settings).
In the US, similar to the UK, the original owner of a stolen good is always considered to have better title. There are vigorous debates over the economic incentives created by favoring original owners over good faith buyers, but the fact remains that Anglo-Saxon law is strongly favoring the property rights of the original owner of a stolen good.
The Sentinel Case
The failed futures brokerage Sentinel Management Group lost the money of its clients in when it went into bankruptcy in 2007. According to the SEC, the firm misappropriated the funds belonging to its clients.
Since then, creditors of the company have been fighting over who has title to certain assets. On the one side are the customers of Sentinel, whose funds and accounts were supposed to have been segregated from the company's assets. On the other side there is New York Mellon Bank, which lent Sentinel $312 million that were secured with collateral mainly consisting of said – allegedly 'segregated' – customer funds.
Reuters informs us now that the unexpected outcome of the Sentinel case means bad tidings for the clients of MF Global, who find themselves in a very similar bind. Below are a few excerpts from the Reuters article – apparently the 'nemo dat' principle does not apply to banks:
“A federal appeals court on Thursday upheld a ruling that puts Bank of New York Mellon ahead of former customers of Sentinel in the line of those seeking the return ofmoney lost in the 2007 failure of the suburban Chicago-based futures broker.
The appeals court affirmed an earlier district court ruling that the bank had a "secured position" on a $312 million loan it gave to Sentinel, which turned out to have been secured by customer money.
Futures brokers are required to keep customers' funds in dedicated accounts to protect them from being used for anything other than client business. However, Thursday's ruling suggests that brokerages can use customer funds to pay off other creditors, Sentinel trustee Fred Grede told Reuters.
"I don't think that's what the Commodity Futures Trading Commission had in mind" with its requirement that brokers keep customer money separate from their own, he said. "It does not bode well for the protection of customer funds."
Worse, Grede said, is that the ruling suggests that a brokerage that allows customer money to be mixed with its own is not necessarily committing fraud.
That may raise the bar for proving that MF Global Holdings Ltd, under then-CEO Jon Corzine, misused customer funds as it scrambled to meet margin calls to back bets on European debt in the brokerage's final days. A $1.6 billion customer shortfall remains.
"I'm sure Mr. Corzine's attorneys will get ahold of this ruling and use it for all it's worth," Grede said.
The appeals court said that "perhaps the bank should have known that Sentinel violated segregation requirements" but agreed with the district court's earlier ruling that "such a lack of care does not rise to the level of the egregious misconduct" needed to reprioritize a claim.
"That Sentinel failed to keep client funds properly segregated is not, on its own, sufficient to rule as a matter of law that Sentinel acted ‘with actual intent to hinder, delay, or defraud' its customers," U.S. Circuit Judge John D. Tinder wrote in the ruling.”
Obviously we are not acquainted with all the details of the case, but there are a few obvious inferences we can draw from the above.
1. What has already come to light in the context of the MF Global case has been confirmed by this case: the so-called 'segregation' of customer funds always was and remains a legal fiction. Segregation of customer funds simply does not exist. Brokers can do with their clients funds whatever they like, just as long as it is not 'intentional fraud'.
2. If customer funds are misappropriated and used as collateral for loans intended for the brokerage's own business dealings, then the 'nemo dat' principle can be safely ignored by the court. Banks that received what were essentially misappropriated goods as collateral do not have to return them to their original owners as long as they are deemed to have acted in good faith. A bank is not forced to exercise care to the extent of ensuring that funds offered as collateral belong to the broker and are not part of the 'segregated' accounts of customers.
3. If customers of futures brokers actually want to protect their 'segregated' funds, they apparently must hire private detectives to run a constant surveillance mission on the brokers holding their funds. The door is now wide open to fraud – with clients evidently forfeiting title to their 'segregated' funds as soon as they are used as collateral for a bank loan, there is nothing to stop anyone from stealing such funds.
4. The fact that the court ruled “That Sentinel failed to keep client funds properly segregated is not, on its own, sufficient to rule as a matter of law that Sentinel acted ‘with actual intent to hinder, delay, or defraud' its customers" is simply breathtaking. According to the SEC, Sentinel quite deliberately defrauded its customers.
Here is an excerpt from a Barron's article that appeared at the time Sentinel was wound up:
“According to people with knowledge of the matter, the SEC and NFA found Sentinel's records a mess. Regulators couldn't seem to get a straight answer to their most basic questions. The job became all the more difficult when Sentinel summarily fired its chief trader and portfolio manager, Charles Mosley, later that week for alleged "misconduct" and then filed for Chapter 11 bankruptcy.
On Aug. 20, the SEC filed a civil action against Sentinel in Federal District Court in Chicago, charging it with fraud, misappropriation and misuse of client money. The agency asserted that Sentinel's daily accounts were "misleading" and that some $600 million of customer money was missing. Moreover, according to the SEC complaint, "at least $460 million" in customer securities had been transferred to a "house account," many of them serving improperly as collateral for loans extended to Sentinel Management Group.
Thus, the SEC dolefully concluded, using the credit crunch to justify the freeze was "false and misleading." It was tantamount to setting a fire to mask a burglary.
But the real blood will be spilled by the hedge funds, commodity traders and wealthy individuals who had about $800 million in Sentinel's Seg-III account. This account, regulators say, was looted to boost Sentinel's house account. The money was pledged as collateral for loans to Sentinel. Driscoll says that Seg-III holders will be lucky to get even half their money. As of two weeks ago, investigators had found only $92 million of the $800 million.
Where are the missing funds? That's what regulators and Sentinel's recently appointed bankruptcy trustee are trying to determine. Sentinel's 42-year-old CEO, Eric Bloom, citing his lawyer's advice, wouldn't discuss the case with a Barron's reporter who went to his home.”
Where indeed are the missing funds? Apparently they have 'vaporized', MF Global style. How could the court possibly conclude that Sentinel was not acting in bad faith and did not intend to defraud its customers? If $460 million in customer funds were 'transferred to a house account' where they were 'serving improperly as collateral for loans extended to Sentinel Management Group', that clearly means they were stolen, respectively 'misappropriated'.
Whether or not Bank New York Mellon had a duty to ascertain the legal status of the pledged collateral, whatever happened to 'nemo dat'? How can stolen goods suddenly be appropriated by the bank that received them in the course of a fraudulent scheme?
Legal questions aside, one thing is already certain: customers of futures brokerages can no longer have faith that their assets are in any way segregated or protected. Whatever residual hope there was left that things may still come right after the MF Global case is surely completely destroyed by the outcome of the Sentinel case.
This is yet another chink in the 'confidence armor' that has propped up the financial system to date. Let us not forget, the fractionally reserved banking system itself is also at variance with traditional legal principles: it routinely appropriates the funds belonging to its depositors for its own business purposes – quite legally as it were.
In reality, the banks can simply not pay all, or even a fraction, of the outstanding depositor claims that are allegedly payable 'on demand'. It is presumably only a very small step for people to realize that the 'vaporization' of customer funds in futures brokerage accounts could happen on a much greater, system-wide scale, if and when push truly comes to shove. This realization itself could well hasten the system's demise.
Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
6 Responses to “The Sentinel Case – Another Nail in the Coffin of ‘Market Confidence’”
Most read in the last 20 days:
- Alan “Bubbles” Greenspan Returns to Gold
Faking It Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. […] The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. — Alan Greenspan, 1961 He was in it for the power and the glory... Alan Greenspan gets presidential bling...
- The Gold Situation
A Growing Bullish Chorus – With Somewhat Muted Enthusiasm A few days ago a well-known mainstream investment house (which shall remain nameless) informed the world that it now expects the gold price to reach “$1,500 by early 2017”. Our first thought was: “Now they tell us!”. You won't be surprised to learn that the same house not too long ago had its eyes firmly fixed in the opposite direction. Da bling be goin' somewhere, fellow rastas and homies! Photo via...
- European Banks and Europe's Never-Ending Crisis
Landfall of a “Told You So” Moment... Late last year and early this year, we wrote extensively about the problems we thought were coming down the pike for European banks. Very little attention was paid to the topic at the time, but we felt it was a typical example of a “gray swan” - a problem everybody knows about on some level, but naively thinks won't erupt if only it is studiously ignored. This actually worked for a while, but as Clouseau would say: “Not...
- End of an Era: The Rise and Fall of the Petrodollar System
The Transition “The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.” Ron Paul A new oil pipeline is built in the Saudi desert... this one is apparently destined for the Ghawar oil field, one of the oldest fields in Saudi Arabia...
- Writing on the Wall
Time to Sell... Maybe BALTIMORE – Yesterday, the S&P 500 hit a new all-time high. And the Dow just hit a new record close as well. If you haven’t sold yet, dear reader, this may be one of the best times ever to do so. It's still flying... sorta. Meet Bill Bonner's tattered crash flag Image credit: fmh We welcome new readers with a simple insight: Markets are contrary, pernicious, and downright untrustworthy. Just when the mob begins to bawl most loudly...
- Gold – Eerie Pattern Repetition Revisited
Gold Continues to Mimic the 1970s Ask and ye shall receive... we promised we would update the comparison chart we last showed in late November in an article that kind of insinuated that it might be a good time to buy gold and gold stocks (see: “Gold and Gold Stocks – It Gets Even More Interesting” for the details). We are hereby delivering on that promise. A Lydian gold stater from the time of the famously rich King Croesus, approx. 570 BC. It seems they already had this...
- Fat People for Trump!
Alphas and Epsilons BALTIMORE – One of the delights of being an American is that it is so easy to feel superior to your fellow countrymen. All you have to do is stand up straight and smile. Or if you really need an ego boost, just go to a local supermarket. Better yet, go to a supermarket with a Trump poster in the parking lot. The protest vote attractor with the funny hair. Image credit: Liberty Maniacs Trigger warning: In the following ramble, we make fun of...
- Destination Mars
Asset Price Levitation One of the more preposterous deeds of modern central banking involves creating digital monetary credits from nothing and then using the faux money to purchase stocks. If you’re unfamiliar with this erudite form of monetary policy this may sound rather fantastical. But, in certain economies, this is now standard operating procedure. The “Tokyo Whale” Haruhiko Kuroda explains his asset purchase madness with a few neat little slides. Photo credit:...
- Planet Debt
Low Interest Rate Persons She is a low-interest-rate person. She has always been a low-interest-rate person. And I must be honest. I am a low-interest-rate person. If we raise interest rates, and if the dollar starts getting too strong, we’re going to have some very major problems. — Donald Trump Two low interest rate persons! The Trumpsumptive president (Donald the Tremendous) can be seen here indicating the approximate size of the interest rate that will...
- America Has Become a “Parasitocracy”
Dread and Denial So, let’s return to the discussion you can’t have with your congressman, your mailman, or your barmaid. It’s the important one. It concerns what the Fed is really up to. Eight years after achieving independence, a State modeled after the British merchant state was established in the US. It took a while for the Deep State to consolidate itself within it, a process that was accelerated greatly in the run-up to and aftermath of WW I. Illustration by Ana...
- Long Term Market Perspectives
Methuselah Tree When looking for a good theme for this post I pondered for a while and then decided to use a picture of a bristlecone pine, which are widely considered to be the oldest living trees in the world. Ye olde bristlecone Photo credit: Kosta Konstantinidis You can find them near the Nevada/California border and if you wind up traveling in the area then I strongly recommend that head over to Bishop and from there head up high up into the White...
- The Central Planning Virus Mutates
Chopper Pilot Descends on Nippon Readers are probably aware of recent events in Japan, the global laboratory for interventionist experiments. The theories of assorted fiscal and monetary cranks have been implemented in spades for more than a quarter of a century in the country, to appropriately catastrophic effect. Amid stubbornly stagnating economic output, Japan has amassed a debt pile so vast since the bursting of its 1980s asset bubble, it beggars the imagination. A...