In Re Manhattan Investment Fund Ltd.

Michael Berger managed the Manhattan Investment Fund Ltd. (the fund) (debtor), a hedge fund that lost about $394 million short-selling stocks. Berger hid losses by fraudulently representing the fund as profitable and persuading new investors to invest while paying off old investors with newly invested money. Bear Stearns (defendant) was the fund’s prime broker, borrowing stocks from third parties, selling them, and holding the proceeds in a margin or “short account.” To close out short positions, Bear Sterns repurchased the stocks and returned them to lenders. Bear Sterns remained obligated to return the stocks, and any loss the fund did not cover exposed Bear Sterns to a loss. Bear Sterns’s senior managing director, Frederick Schilling, learned Berger was reporting profits when Schilling believed the fund was losing money. Berger explained the discrepancy resulted from using other prime brokers. Despite an audit supposedly reporting the fund in good standing, Bear Sterns continued its inquiry and learned more information that sounded wrong and that the auditor did not have the fund as a client. A credit check and financial statements revealed the fund had only one prime broker. Bear Sterns reported the fund, and the Securities and Exchange Commission shut the fund down, froze the assets, and had a trustee (plaintiff) appointed as receiver. After the fund filed for bankruptcy, the trustee brought an adversary proceeding to recover the $141 million that short sellers had transferred to Bear Sterns’s short account in the year before the fund collapsed. The bankruptcy court granted the trustee summary judgment. Bear Sterns appealed.