RTC has failed to show that GreatAmerican relied on any security in its possession that is stolen within the meaning of Insuring Agreement E.
Even if we were to conclude that the loss suffered by GreatAmerican fell within the coverage extended under Insuring Agreement E, RTC has failed to establish that GreatAmerican, its corresponding institution or other authorized representative had "actual possession" of the securities at the time of the loss. Actual possession is a condition precedent to coverage under Insuring Agreement E.
It is undisputed that GreatAmerican never took physical delivery of the securities that it supposedly relied upon when entering into the repo portions of the transactions at issue. Instead, BBS or its clearing agents, Bradford and Security Pacific, maintained control over the securities throughout the tenure of the repo and reverse repo in question. However, RTC argues that even though GreatAmerican never took actual physical delivery of the securities it relied upon for the repo transactions, it had "actual possession" of the securities because BBS or its registered agents were acting as GreatAmerican's agent or registered representative for purposes of holding the securities.
There is simply no evidence that BBS or its clearing agents, Bradford or Security Pacific, were acting as GreatAmerican's agent either before, during or after the terms of the repo and reverse repo were negotiated. Instead, the evidence shows that GreatAmerican and BBS were engaged in arms length negotiations for each party's benefit. The confirmation slips indicate that BBS was acting as a principal for its own account in its transactions with GreatAmerican. In fact, the confirmation slips refer to GreatAmerican as "contra party." Thus, it is clear that BBS and GreatAmerican's relationship was one of principal/principal and not one of principal/agent.
Further, there is simply no evidence that Bradford and/or Security Pacific were acting as GreatAmerican's corresponding institution or authorized representative. "A corresponding bank is one which regularly performs services for another in a place or market to which the other does not have direct access." Securities Fund v. Am. Nat'l. Bank & Trust Co., 542 F. Supp. 323 (N.D. Ill. 1982). Bradford and Security Pacific were clearly not acting in this manner for GreatAmerican.
Further, the term "authorized representative" connotes an "agency requirement" which did not exist between GreatAmerican and BBS' clearing agents. See National City Bank v. St. Paul Fire and Marine Inc. Co., 447 N.W.2d 171, 176 (Minn. 1989). As clearing agents for BBS, Bradford and Security Pacific were not acting as custodial banks for GreatAmerican. Neither took directions from or had any direct communication with GreatAmerican concerning the underlying securities to the repo transactions and GreatAmerican never received any separate statements of account concerning these securities.
In fact, the record shows that Bradford and Security Pacific only took instruction from BBS and that BBS had unrestricted access to the securities being held in accounts at Bradford and Security Pacific. More importantly, even if the securities were held in a safekeeping account, the securities were not held or segregated in the BBS accounts by reference to third parties like GreatAmerican. All instructions as to whether securities should be held in safekeeping or clearing accounts came from BBS and BBS could remove the securities from either account at any time.
As the bankruptcy court noted, "the only party to have actual physical possession of the security in the AMC test cases was Security Pacific, and at no time was it acting as a designee of any of the repo participants." In re Bevill, Bresler & Schulman Asset Management Corp., 67 Bankr. 557, 604 (Bankr. D.N.J. 1986).
For the reasons stated above, Insuring Agreement E does not cover the losses suffered by GreatAmerican at the hands of BBS and AMC. GreatAmerican chose not to take delivery of the securities but, instead, to leave them in the custody of BBS. RTC must live with the consequences of this choice.
2. Insuring Agreement B
RTC next argues that GreatAmerican's losses fall squarely within the coverage provided by Insuring Agreement B. Insuring Agreement B provides coverage for loss of property resulting from misplacement or disappearance while that property is lodged or deposited within the premises and for losses resulting from theft or fraud committed by a person present on the premises in which the property is lodged or deposited. However, coverage under Insuring Agreement B is subject to various exclusions. In this case, Aetna argues that coverage for the claimed losses is excluded under both exclusion (e) and (i) of the Bond. Since we conclude that GreatAmerican's losses are excluded under "loan loss" exclusion (e), we will not address the parties arguments concerning "trade loss" exclusion (i).
Exclusion (e) of Insuring Agreement B excludes all losses "resulting directly or indirectly from the complete or partial nonpayment of, or default upon, any loan or transaction in the nature of a loan or extension of credit."
First, we conclude that exclusion (e) is unambiguous. See Liberty Savings Bank v. American Casualty Co., 754 F. Supp. 559, 561 (1990). Therefore, we will apply the exclusion according to its terms. See Continental Corporation v. Aetna Casualty & Surety Co., 892 F.2d 540, 544 (7th Cir. 1989). Second, this court has found that loan loss exclusions like exclusion (e) are valid affirmative defenses to coverage under a bond. See Lincoln-Way Federal Savings Bank v. Employers Insurance of Wausau, 717 F. Supp. 617, 620 (N.D. Ill. 1989). Therefore, the only issue before the court is whether the loss sustained by GreatAmerican fits under the terms of the exclusion clause.
With regards to this issue, RTC argues that the repo and reverse repo transactions in question were purchases and sales of securities and, therefore, outside the scope of exclusion (e). Aetna, on the other hand, argues that these transactions, although not outright loans, were either "de facto" loans or "transactions in the nature of the loan or extension of credit." Thus, Aetna argues coverage for the losses sustained by GreatAmerican is barred under exclusion (e).
Given the hybrid nature of repo transactions, it is not surprising that RTC and Aetna have such differing opinions as to the proper characterization of a repo and reverse repo.
There is simply no question that repo and reverse repo transactions have functional attributes which resemble short-term collateralized loans. As one court stated:
From a purely economic perspective, . . . a repo is essentially a short-term collateralized loan, and the parties to these transactions tend to perceive them as such. The element of the transaction over which the most bargaining usually occurs is in the interest rate. The parties customarily refer to the underlying securities as "collateral," and the risk of a change in the value of the collateral remains with the borrower, even though the lender "owns" it for the term of the agreement.
S.E.C. v. Miller, 495 F. Supp. 465, 467 (S.D.N.Y. 1980). However, repos also possess many of the benefits of an outright sale and purchase of a security. See In the Matter of Bevill, Bresler and Schulman Asset Management Corporation v. Army Moral Support Fund, 67 Bankr. 557 (D.N.J. 1986).
When determining whether a particular repo transaction should be treated as a loan or a sale and purchase of security must be made on a case by case basis. First Federal Savings & Loan Assoc. of Toledo v. Fidelity & Deposit Co. of Maryland, 895 F.2d 254, 260 (6th Cir. 1990). In First Toledo, the court laid out the factors that should be considered in determining whether a particular repo transaction should be considered a loan. These factors include:
(1) whether the seller could require the purchaser to resell;