In Petition to Vacate FINRA Arbitration Award, Goldman Seeks to Define the Scope of a Prime Broker’s Duty (If Any) to Investors in a Hedge Fund that is a Customer of the Prime Broker

On July 23, 2010, Goldman Sachs petitioned the U.S. District Court for the Southern District of New York to vacate the June 24, 2010, Financial Industry Regulatory Authority (FINRA) arbitration award ordering it to pay $20.58 million to the bankruptcy estate of Bayou Group, LLC.  The Official Unsecured Creditors’ Committee of the estate (Committee) had filed a claim in arbitration against Goldman Sachs Execution & Clearing, L.P. (Goldman), claiming that, in its role as prime broker and clearing broker to the Bayou funds, Goldman failed to investigate the Ponzi scheme committed by the funds’ principals in the face of numerous red flags, and accepted fraudulent transfers and conveyances.  In its answer, Goldman argued that, as a matter of law, it could not be held accountable for the $20.58 million that the Bayou funds deposited in their own trading accounts and transferred among those accounts, because the Bayou funds never actually conveyed the money to Goldman as required for a fraudulent transfer, and because, as a clearing firm and prime broker, Goldman had no legal duty to monitor the suitability of transactions by or the finances of its account holders.  In its petition to vacate the award, Goldman stated that “the arbitration panel manifestly disregarded the law and exceeded its authority” for similar reasons.  We detail the background of the action, the claims for relief in the arbitration, and Goldman’s petition to vacate the award.  The case is of central importance in defining the scope of a prime broker’s duty to investors in a hedge fund that is a customer of the prime broker, in cases where the prime broker knows, should know or with reasonable diligence can discover information that may suggest fraud or other bad acts on the part of the manager of the customer hedge fund.  See, by way of background, “Bayou Creditors Sue Goldman Prime Brokerage Unit to Avoid Allegedly Fraudulent Transfers,” Hedge Fund Law Report, Vol. 1, No. 13 (May 30, 2008).

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