In re Refco Cap. Markets Brokerage Cust. Sec. Lit.

• Decision Date: 28 August 2008
• Docket Number: No. 07 Civ. 8686(GEL).,No. 06 Civ. 643(GEL).,No. 07 Civ. 8688(GEL).,06 Civ. 643(GEL).,07 Civ. 8686(GEL).,07 Civ. 8688(GEL).
• Citation: 586 F.Supp.2d 172
• Parties: In re REFCO CAPITAL MARKETS, LTD. BROKERAGE CUSTOMER SECURITIES LITIGATION. VR Global Partners, L.P. et al., Plaintiffs, v. Phillip R. Bennett et al., Defendants. Capital Management Select Fund Ltd. et al., Plaintiffs, v. Phillip R. Bennett et al., Defendants.
• Court: U.S. District Court — Southern District of New York

586 F.Supp.2d 172

In re REFCO CAPITAL MARKETS, LTD. BROKERAGE CUSTOMER SECURITIES LITIGATION.

VR Global Partners, L.P. et al., Plaintiffs, v. Phillip R. Bennett et al., Defendants.

Capital Management Select Fund Ltd. et al., Plaintiffs, v. Phillip R. Bennett et al., Defendants.

No. 06 Civ. 643(GEL).

No. 07 Civ. 8686(GEL).

No. 07 Civ. 8688(GEL).

United States District Court, S.D. New York.

August 28, 2008.

Scott A. Edelman, Sander Bak, Michael Shepherd, Milbank, Tweed, Hadley & McCloy LLP, New York, NY, for Lead Plaintiffs and the Prospective Class, VR Plaintiffs, and Capital Plaintiffs.

Mark A. Strauss, Richard L. Stone, Kirby Mclnerney & Squire LLP, New York, NY, for Lead Plaintiffs and the Prospective Class.

Norman L. Eisen, Laura E. Neish, Zuckerman Spaeder LLP, New York, NY, and Blake T. Hannafan, Michael T. Hannafan, Hannafan & Hannafan, Ltd., Chicago, IL, for defendant Tone N. Grant.

David E. Mollon, Bradley E. Lerman, Catherine W. Joyce, Linda T. Coberly, Winston & Strawn LLP, New York, NY, and Chicago, IL, and Margaret Maxwell Zagel, Kenneth Cunningham, Grant Thornton LLP, Chicago, IL, for defendant Grant Thornton LLP.

Matthew J. Sava, Yoram J. Miller, Jason Vigna, Shapiro Forman Allen & Sava LLP, New York, NY, for defendant Joseph J. Murphy.

Stuart I. Friedman, Ivan 0. Kline, Elizabeth Meacham, Friedman & Wittenstein, New York, NY, for defendant William M. Sexton.

Lawrence J. Zweifach, Richard Cashman, Eric Creizman, Heller Ehrman LLP, New York, NY, for defendant Philip Silverman.

Barbara Moses, Rachel Korenblat, James Darrow, Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C., New York, NY, for defendant Robert C. Trosten.

Richard A. Rosen, Paul Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, and Greg A. Danilow, Weil, Gotshal & Manges LLP, New York, NY, for the THL Defendants.

Claire Perlman Gutekunst, Jessica Mastrogiovanni, Proskauer Rose LLP, New York, NY, for defendant Richard N. Outridge.

OPINION AND ORDER

GERARD E. LYNCH, District Judge.

On September 13, 2007, this Court dismissed the securities fraud complaint in the putative class action, In re Refco Capital Markets, Ltd. Brokerage Customer Securities Litigation, No. 06 Civ. 643, 2007 WL 2694469, at *12-13 (S.D.N.Y. Sept. 13, 2007) (hereinafter "RCM I), for failure to allege deceptive conduct, but granted Lead Plaintiffs leave to replead as to certain defendants. Thereafter, two groups of plaintiffs brought individual actions based on allegations substantially similar to those advanced by Lead Plaintiffs in the putative class action. See VR Global Partners, L.P. et al. v. Bennett et al, No. 07 Civ. 8686(GEL), 2007 WL 4837764 (S.D.N.Y. filed Oct. 9, 2007); Capital Mgmt. Select Fund Ltd. et al. v. Bennett et al, No. 07 Civ. 8688(GEL), 2007 WL 4837768 (S.D.N.Y. filed Oct. 9, 2007). On November 20, 2007, the Court consolidated all three actions for pretrial purposes. Lead Plaintiffs in due course filed a Second Amended Complaint in the putative class action.

This opinion addresses fifteen motions to dismiss filed in the consolidated actions by various former corporate officers of Refco,¹ Refco's auditor Grant Thornton LLP, and a group of defendants affiliated with Thomas H. Lee Partners, L.P. (the "THL Defendants"), who collectively owned a majority interest in Refco at all times relevant to the pending actions. Because plaintiffs lack standing to assert their claims for securities fraud and, in any event, fail to allege deceptive conduct, the motions to dismiss will be granted in their entirety, and plaintiffs' request for leave to replead will be denied with prejudice.

BACKGROUND

The initial discussion of background facts will be brief, as the facts are fully set forth in the Court's prior opinion in RCM I. Detailed discussions of relevant factual allegations will be reserved for the legal analyses that require them.

I. The Parties

Plaintiffs in the consolidated actions are all former customers of Refco Capital Markets, Ltd. ("RCM"), a Refco subsidiary that operated as a securities brokerage firm. In the putative class action, Lead Plaintiffs Global Management Worldwide Limited, Arbat Equity Arbitrage Fund Limited, and Russian Investors Securities Limited are "commonly controlled investment funds" who represent a prospective class of RCM customers who "placed securities with or held securities at" RCM (and/or its sister company Refco Securities, LLC ("RSL")) at any time from October 17, 2000, to October 17, 2005, and elected to contribute the proceeds of their claims to the Refco Private Action Trust (collectively, the "Class Plaintiffs").² (P. Mem. 9; Class Compl. ¶¶ 2, 34-38.³) In the VR Global action, plaintiffs VR Global Partners, L.P., Paton Holdings, Ltd., VR Capital Group Ltd., and VR Argentina Recovery Fund, Ltd. (collectively, the "VR Plaintiffs") describe themselves as "one of the top-ranked emerging markets funds in the world, achieving a 43% annual compound return for its investors, net of fees, over its six year existence prior to the Refco debacle." (VR Compl. ¶ 81.) Plaintiffs in the Capital Management Action, Capital Management Select Fund Ltd., Investment & Development Finance Corporation, and IDC Financial S.A., are offshore investment funds incorporated in the Bahamas, British Virgin Islands, and Panama respectively (collectively, the "Capital Plaintiffs"). (Capital Compl. ¶¶ 31-33.)

Various former corporate officers of Refco and/or RCM are named as defendants in the consolidated actions (collectively, the "Officer Defendants").⁴ Defendant Grant Thornton LLP, RCM's auditor, is sued only in the VR Global action. Grant Thornton provided auditing services in connection with RCM's financial statements for the fiscal years ending in February 2003, 2004, and 2005, and issued unqualified audit opinion letters for each of those fiscal years. (VR Compl. ¶ 78.) The THL Defendants are entities or individuals affiliated with defendant Thomas H. Lee Partners, L.P., a private equity firm.⁵ (Class Compl. ¶¶ 54-62; VR Compl. ¶¶ 69-77; Capital Compl. ¶¶ 51-59.) In August 2004, one year prior to Refco's initial public offering ("IPO"), the THL Defendants purchased a 57% equity stake in Refco for approximately $507 million. (Class Compl. ¶ 56; VR Compl. ¶ 71; Capital Compl. ¶ 53.) After the IPO, the THL Defendants continued to hold a dominant 43% interest in Refco. (Class Compl. ¶ 62; VR Compl. ¶ 77; Capital Compl. ¶ 59.)

II. The Alleged Scheme

As noted in RCM I, the fraud alleged in the RCM customer actions is distinct from the fraudulent scheme alleged in the Refco shareholders' class action and related cases, see, e.g., In re Refco, Inc. Sees. Litig., 503 F.Supp.2d 611, 618-20 (S.D.N.Y.2007); Thomas H. Lee Equity Fund V, L.P. v. Grant Thornton LLP, No. 07 Civ. 8663, 2008 WL 3166536, at *1-2 (S.D.N.Y. Aug. 6, 2008), which involved the purported manipulation of Refco's financial condition through a "round-robin fraud" designed to erase a massive uncollectible receivable from Refco's books at the end of each financial reporting period, RCM I, 2007 WL 2694469, at *1, *4. Plaintiffs in the pending actions allege a separate scheme in which RCM allegedly sold customer assets without authorization and improperly used the proceeds to make loans and fund the business operations of other Refco affiliates.⁶ (Class Compl. ¶ 5; VR Compl. ¶ 5; Capital Compl. ¶ 4.)

In particular, plaintiffs allege that they each opened non-discretionary trading accounts at RCM, which meant that any transactions made by RCM on their behalf required their advance approval. (Class Compl. ¶ 4; VR Compl. ¶ 4; Capital Compl. ¶ 3.) According to plaintiffs, RCM routinely sold, hypothecated, or pledged their securities without their authorization in violation of their customer agreements with RCM and in contravention of oral representations made by Refco representatives that RCM would hold their securities for safekeeping. (See Class Compl. ¶¶8, 10; VR Compl. ¶¶8,10; Capital Compl. ¶¶ 7, 9.) Plaintiffs contend that they were misled by RCM's monthly account statements and trade confirmations, which purportedly failed to disclose RCM's sales of their securities. (Class Compl. ¶ 11; VR Compl. ¶ 11, 105; Capital Compl. ¶ 10.) Plaintiffs also allege that RCM owed them a fiduciary duty and that its unauthorized sale of their assets breached that duty. (Class Compl. ¶ 9; VR Compl. ¶ 9; Capital Compl. ¶8.)

On October 10, 2005, just two months after its IPO, Refco disclosed that it had discovered a receivable in the amount of $430 million due from an entity controlled by Refco's CEO, Philip R. Bennett. As a result, the company announced that its financial statements for the preceding four years could no longer be relied upon. On October 17, 2005, Refco and many of its subsidiaries, including RCM, filed for bankruptcy protection under Chapter 11 of Title 11 of the United States Code. (Class Comp. ¶¶ 152-54; VR Compl. ¶¶ 236-38; Capital Compl. ¶¶ 155-57.)

Following Refco's disclosure of the $430 million receivable, many RCM customers, including plaintiffs, attempted to "withdraw securities and funds that they entrusted to RCM." (Class Compl. ¶ 153; VR Compl. ¶ 237; Capital Compl. ¶ 156.) Refco responded by imposing a moratorium on all withdrawals from RCM customer accounts. (Class Compl. ¶ 153; VR Compl. ¶¶ 237-38; Capital Compl. ¶ 156.) In bankruptcy proceedings, RCM acknowledged that it owes its customers approximately $4.16 billion, but has only $1,905 billion in assets. (Class Compl. ¶¶ 156-57; VR Compl. ¶¶ 240-41; Capital Compl. ¶¶ 159-60.) RCM also disclosed that "the majority of RCM's customer property had been transferred to other Refco entities ... through a series of intercompany `loans.'" (Class Compl. ¶ 156; VR Compl. ¶ 240; Capital Compl. ¶159.) As a result of RCM's allegedly deceptive conduct, plaintiffs purportedly suffered hundreds of millions of dollars in losses. (See Class Compl. ¶ 28; VR Compl. ¶ 28; Capital Compl. ¶ 25.)

III. C...