In re Refco, Inc. Securities Litigation

Citation503 F.Supp.2d 611
Decision Date30 April 2007
Docket NumberNo. 05 Civ. 8626(GEL).,05 Civ. 8626(GEL).
CourtU.S. District Court — Southern District of New York

John P. Coffey, Max W. Berger, Salvatore J. Graziano, John C. Browne, and Jeremy P. Robinson, Bernstein Litowitz Berger & Grossman LLP, New York, New York, and Stuart M. Grant, James J. Sabena, Megan D. McIntyre, Jeff A. Almeida, Christine M. Mackintosh, and Jill Agro, Grant & Eisenhofer PA., New York, New York and Wilmington, Delaware, for Lead Plaintiffs Pacific Investment Management Company, LLC and RH "Capital LLC and the Prospective Class.

Robert B. McCaw, Lori A. Martin, John V.H. Pierce, and Dawn M. Wilson, Wilmer Cutler Pickering Hale and Dorr LLP, New York, New York, for the "144A" or "Bond Underwriter" Defendants.

Jeffrey T. Golenbock and Adam C. Silverstein, Golenbock Eiseman Assor Bell & Peskoe LLP, New York, New York, for Defendants Phillip R. Bennett, Refco

Group Holdings Inc., and Phillip R. Bennett Three Year Annuity Trust.

Bruce R. Braun, Bradley E. Lerman, Linda T. Coberly, and David Mollón, Winston & Strawn LLP, New York, New York and Chicago, Illinois, and Margaret Maxwell Zegel and Tracy W. Berry, Grant Thornton LLP, Chicago, Illinois, for Defendant Grant Thornton LLP.

Michael T. Hannafan, Blake T. Hannafan, and Nicholas A. Pavich, Hannafan & Hannafan, Ltd., Chicago, Illinois, and Norman Eisen and Melinda Sarafa, Zuckerman Spaeder LLP, New York, New York, for Defendant Tone Grant.

Helen B. Kim and Marc D. Powers, Baker & Hostetler LLP, New York, New York and Los Angeles, California, and Richard E. Nathan, Nathan Law Office, Los Angeles, California, for Defendant Dennis A. Kleina.

Stuart L. Shapiro, Matthew J. Sava, and Yoram J. Miller, Shapiro Forman Allen Sava & McPherson LLP, New York, New York, for Defendants Joseph J. Murphy and Gerald M. Sherer.

Ivan Kline, Stuart I. Friedman, and Elizabeth D. Meacham, Friedman & Wittenstein, New York, New York, for Defendant William M. Sexton.

Holly K. Kulka, Heller Ehrman LLP, New York, New York, for Defendant Philip Silverman.

Greg' A. Danilow and Paul Dutka (Seth Goodchild and Joshua S. Amsel, on the brief), Weil, Gotshal & Manges LLP, New York, New York, for the "THL" and "Audit Committee" Defendants.

Barbara Moses and Rachel Korenblat, Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C., New York, New York, for Defendant Robert Trosten.


LYNCH, District Judge.

Various defendants in this large securities class action arising from the collapse of Refco Inc. and its affiliated companies ("Refco") move for dismissal or partial dismissal of the First Amended Complaint as to them. This opinion addresses ten motions to dismiss by twenty-eight defendants, many of whom raise overlapping arguments. Accordingly, to avoid an unduly duplicative and lengthy opinion, the movants' legal arguments will be grouped together. Detailed discussions of relevant factual allegations will be reserved for the legal analyses that require them, and the initial discussion of background facts will accordingly be brief.


I. The Allegations

A. The Alleged Fraudulent Scheme

Refco was a provider of brokerage and clearing services in the international derivatives, currency and futures markets.1 Part of Refco's business model involved giving loans to its trading clients, which the clients then used to leverage larger trades. (Compl. ¶¶ 2, 87, 382.) At a certain point, Refco began making loans without adequately assessing the customers' credit-worthiness or their trading activities. These risky loans began to backfire in 1997 and 1998, when several global financial crises caused Refco and a number of its largest customers to suffer massive trading losses. (Compl. ¶¶ 31, 383-97.) The loans were now "uncollectible receivables" that would never be paid. (P. Mem. 8.)

Rather than disclose these uncollectible receivables to the public and Refco's investors, Refco's management allegedly devised a scheme to hide them. First, they transferred the loans onto the books of Refco Group Holdings, Inc. ("RGHI"), an entity owned and controlled by defendant Phillip R. Bennett, Refco's president, CEO, and Chairman (Compl. ¶ 32) and Tone Grant, Bennett's predecessor as CEO (id. ¶ 41). As a result, RGHI owed hundreds of millions of dollars to Refco. In order to hide RGHI's obligation to Refco, the complaint alleges, a series of fraudulent transactions were arranged by which the RGHI receivable was made to disappear from Refco's books.

The transactions all worked in essentially the same way. First, Refco Capital (a Refco subsidiary) would make loans to a third party.2 This money was transferred into accounts in the third party's name at Refco. (Compl. ¶¶ 417-18). The third party would then loan an equivalent amount to RGHI; the loan agreements between the third party and Refco Capital required that the money be used only for that purpose.3 (Id. ¶ 411.) These loans to RGHI were guaranteed by Refco itself; Bennett — on behalf of Refco as guarantor — signed the loan agreement between the third party and RGHI. (Compl. ¶¶ 415-18.) RGHI then used the loan from the third party to pay down the money it owed to Refco for the uncollectible receivables. (Compl. ¶ 416.) Thus, Refco Capital was loaning money to RGHI for use in temporarily paying off its debt to Refco. This series of transactions would take place a few days before the end of the relevant financial period, and would be undone within two weeks. (Compl. ¶ 409).

The loans in question were substantially greater than Refco's reported net income. A February 2005 loan, for example, was for $595 million, 337% of Refco's reported net income for the relevant fiscal year. (Compl. ¶ 560.), A February 2004 loan was for $970 million, 518% of Refco's reported net income for the relevant fiscal year. (Id.) If compared to quarterly income, of course, the size of the loans is even more dramatic: a November 2004 loan for $545 million was the equivalent of 3,045% of Refco's reported net income for that quarter. (Id.)4

Thus, Refco Capital was loaning enormous sums of money to the third party while Refco guaranteed an equivalent loan from the third party to RGHI. Meanwhile, Refco Capital — not RGHI — paid to the third party the interest purportedly owed by RGHI. (Id. ¶ 563.) The transactions took place in substantially the same form over the course of six years.

None of these transactions was disclosed to the public in the filings discussed below. Thus, in effect, Refco was loaning money to itself, through third parties, to hide its dismal financial situation from the public and its investors.

B. The Relevant Transactions

The various transactions at issue in this case took place while the fraudulent scheme above was ongoing.

1. The Rule 144A Bonds and the Exxon Capital Exchange

In June 2004, Refco issued $600 million of 9% Senior Subordinated Notes due in 2012. These bonds were sold to the defendants referred to by plaintiffs as the "Bond Underwriter Defendants," who call themselves the "144A Defendants." These defendants then immediately resold the bonds to institutional buyers, including some of the plaintiffs. (See Compl. ¶¶ 94-95, 100-08.) The bonds were unregistered pursuant to Securities and Exchange Commission ("SEC") Rule 144A, 17 C.F.R. § 230.144A, which exempts private placements to qualified institutional buyers from the registration requirements of the Securities Act, and were thus issued pursuant to an offering memorandum rather than a registration statement. (Compl. ¶¶ 105-108.) Plaintiffs allege that this offering memorandum contained various false statements concerning Refco's financial performance and viability. (Id. ¶¶ 109-143.) The unregistered bond offering was marketed to institutional investors at a nationwide road show in July 2004 (the "Road Show").

Plaintiffs argue that this unregistered bond offering was the first step in a single plan of financing. The second step in this putative plan came when Refco issued registered bonds, which holders of the Rule 144A Bonds acquired by exchanging their Rule 144A bonds for registered bonds in a transaction known as an "Exxon Capital exchange."

The registered bond offering was made pursuant to a Form S-4 Registration Statement (Wilson Decl. Ex. C) (the "Bond Registration Statement"), which was filed with the SEC on October 12, 2004, and became effective on the day the registered bonds were issued, April 13, 2005. The registration statement was not yet effective at the time of the Rule 144A offering. (Compl. ¶¶ 149-50.). Plaintiffs allege that this statement, too, contained various false statements of material fact. (Id. ¶¶ 153-65.)

2. The August 2005 IPO

In August 2005, Refco conducted a successful initial public offering ("IPO"), underwritten by fifteen banks including the three banks that served as underwriters for the Rule 144A offering. (See P. Mem. 14 n. 8). In the IPO, Refco sold approximately 20% of its shares to plaintiff RH Capital and other members of the putative class. (Compl. ¶ 166.) The IPO was conducted pursuant to a Form S-1 registration statement dated April 8, 2005, Form S-1/A registration statements dated May 27, July 1, July 20, July 25, August 8, and August 10, 2005, and a Form 424B1 prospectus dated August 10, 2005. (Id. ¶ 168.) Again, plaintiffs allege that these filings contained false statements of material fact. (Id. ¶¶ 172-98.)

3. The October 2005 Press Release and Refco's Collapse

On October 10, 2005, Refco issued a press release announcing that it had discovered an "undisclosed affiliate transaction." (Id. ¶ 199.) The press release disclosed the existence of a $340 million receivable owed to the company by "an entity controlled by Phillip R. Bennett" (that is, RGHI), and indicated that Bennett had repaid the receivable in cash as of October...

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