Krys v. Aaron (In re Refco Inc. Sec. Litig.)
| Decision Date | 30 March 2011 |
| Docket Number | 08 Civ. 7416 (JSR).,Nos. 07 MDL 1902 (JSR),s. 07 MDL 1902 (JSR) |
| Citation | 826 F.Supp.2d 478 |
| Parties | In re REFCO INC. SECURITIES LITIGATION.This Document Relates to:Kenneth M. Krys, et al., Plaintiffs, v. Richard Aaron, et al., Defendants. |
| Court | U.S. District Court — Southern District of New York |
OPINION TEXT STARTS HERE
On July 19, 2010, Special Master Daniel J. Capra issued a Report and Recommendation in the above-captioned case recommending that the Court adopt the following conclusions:
Count I, Breach of Contract:
• Count I should be dismissed as to Aaron and Castranova, with prejudice.
• The claim that Mellon is liable for breaching the Service Agreement should be dismissed with prejudice.
Count II, Breach of the Covenant of Good Faith and Fair Dealing:
• Count II should be dismissed with prejudice.
Count III, Indemnity:
• Count III should be dismissed as to Mellon, with prejudice.
Count VI, Declaratory Relief:
• Count IV should be dismissed as to Castranova, with prejudice.
Count V, Breach of Fiduciary Duty:
• The DPM entities' motion to dismiss should be denied.
• PlusFunds' claim against Aaron should be dismissed, with prejudice.
• Aaron's motion to dismiss SMFF's claim should be denied.
• Count V should be dismissed as to Castranova, with prejudice.
• Count V should be dismissed as to Mellon, with prejudice.
Count VI, Aiding and Abetting Breach of Fiduciary Duty:
• The motions to dismiss should be denied with respect to all Defendants except Mellon.
• Count VI should be dismissed as to Mellon, with prejudice.
Count VII, Interference with Contract/Prospective Contract:
• Count VII should be dismissed with prejudice.
Count VIII, Fraud/Misrepresentation:
• The motions to dismiss should be denied with respect to all Defendants except Mellon.
• Count VII should be dismissed as to Mellon, with prejudice.
Count IX, Aiding and Abetting Interference with Contract/Prospective Contract:
• Count IX should be dismissed with prejudice.
Count X, NJRICO:
• Count X should be dismissed with prejudice.
See 07/19/10 R & R at 62–64.
After the various parties timely submitted objections to the Special Master's recommendations and responses to those objections, the Court heard oral argument on October 28, 2010. Having now reviewed the matter de novo, the Court finds itself fully persuaded by the Special Master's typically comprehensive and well-reasoned Report and Recommendation and hereby adopts it in full as if incorporated herein.
Finding nothing to add to the Special Master's excellent Report and Recommendation, the Court hereby affirms and adopts in all respects the conclusions set forth above.
SO ORDERED.
The defendants in this action move to dismiss almost all the counts in the complaint against them arising from losses suffered when assets were allegedly transferred from segregated accounts at Refco LLC to unprotected accounts at Refco Capital Markets, Ltd. (“RCM”). According to the First Amended Complaint, this action is brought to recover (i) $263 million plus interest in damages suffered by the SPhinX family of hedge funds (“SPhinX”); (ii) the lost business enterprise value and deepening insolvency damages suffered by SPhinX's investment manager, PlusFunds Group, Inc., (“PlusFunds”); and (iii) damages suffered by the Assignors, a group comprised of SPhinX investors. First Amended Complaint (“FAC”) ¶ 1. The gravamen of the complaint is that SPhinX's excess cash was diverted “from protected, customer segregated accounts to unprotected offshore accounts, where those assets were ultimately lost in the Refco scandal.” Id.1
I. IntroductionA. The Parties
There are three sets of claimants:
1. The SPhinX family of funds, organized under Cayman Islands law, entered into voluntary liquidation after the fall of Refco. Plaintiffs Kenneth M. Krys and Margot MacInnis are their Joint Official Liquidators.2
2. Plaintiff The Harbor Trust Co. Ltd. is the Trustee of the SPhinX Trust. 3 The SPhinX Trust is the assignee of claims from the estate of PlusFunds. PlusFunds created SPhinX and served as its investment manager.
3. Mr. Krys and Ms. MacInnis are also pursuing claims that have been assigned by sixteen entities that were SPhinX Funds investors. These claims will be referred to as “Investors' claims” or “Assignors' claims.”
B. The Standing Opinion
In an Order dated March 31, 2010, Judge Rakoff adopted the conclusions in a Report and Recommendation of the Special Master regarding issues of standing. Insofar as relevant here, that Order provides the following:
1. All claims brought by the Assignors have been dismissed with prejudice for lack of standing, because they replicate claims brought by SPhinX.
2. All claims brought by any SPhinX entities other than SPhinX Managed Futures Fund (“SMFF”) have been dismissed with prejudice, because the claims of the other entities are derivative of those pursued by SMFF.4
3. The motions to dismiss the claims of PlusFunds on grounds of standing have been denied because PlusFunds is alleging direct injury and damages independent from those of SMFF.
Accordingly, this Report and Recommendation will consider the instant motions to dismiss only insofar as they involve SMFF and PlusFunds.
C. The Defendants
1. Derivative Portfolio Management LLC (a Delaware company), and Derivative Portfolio Management Ltd. (a Cayman Islands entity) together served as SPhinX's administrator pursuant to a Service Agreement. The assets and liabilities of both entities were acquired in 2005 by Mellon Financial Corporation, after which they were operated respectively as DPM–Mellon LLC, a Delaware limited liability company, and DPM–Mellon Ltd., a Cayman Islands entity (collectively, “DPM–Mellon”). After the acquisitions, DPM–Mellon served as SPhinX's administrator pursuant to the Service Agreement. This Report and Recommendation will refer to all the DPM and DPM–Mellon entities collectively as “DPM.” or “the DPM entities.”
2. Bank of New York Mellon Corporation f/k/a Mellon Financial Corporation (“Mellon”), a Delaware corporation, allegedly “controlled DPM–Mellon” (FAC ¶ 35) and is assertedly liable for the acts and omissions of DPM.
3. Robert Aaron was a director of SPhinX from 2002 to 2006 and was the founder, Chief Executive Officer, part owner and member of the board of directors of DPM “at all times relevant.” FAC ¶ 38.
4. Guy Castranova was President, Chief Operating Officer, part-owner and member of the board of directors of DPM “at all times relevant.” FAC ¶ 39. Aaron and Castranova will from time to time be referred to as “the Individual Defendants.” 5
D. Facts Forming the Basis of the Complaint
The gravamen of the complaint is that SMFF excess cash in segregated accounts at Refco LLC were—without authorization—swept into commingled accounts at RCM and ultimately lost in the Refco scandal because they were not protected from RCM's insolvency. The basic allegations in the First Amended Complaint specific to the Defendants can be summarized as follows:
1. SMFF entered into an Investment Management Agreement (IMA) with PlusFunds, under which PlusFunds was the exclusive investment manager for SMFF. FAC ¶¶ 86–88. PlusFunds retained Refco LLC to provide execution, clearing and margin services. FAC ¶ 95. SMFF funds at Refco LLC were protected in the event of Refco LLC's insolvency. FAC ¶ 97.
2. PlusFunds engaged DPM to serve as administrator for the SPhinX funds. The relationship among SPhinX, PlusFunds, and DPM was governed by a Service Agreement dated July 9, 2002, and amended on May 1, 2003 and June 30, 2004 (collectively, the “Service Agreement”). FAC 1103. The Service Agreement required DPM to perform all services necessary for administration and reconciliation of the SPhinX funds, including but not limited to providing: daily activity reports; daily reconciliations; daily and monthly valuations and NAV reports; reconciliations of marketable instruments, cash and security positions; monthly reports, including gains and losses, accrued dividend and interest analysis; market and credit risk reports; corporate secretarial functions; and quarterly, unaudited financial statements. FAC ¶ 107. The Service Agreement required DPM to perform treasury functions including investment of excess cash. FAC ¶ 115.6
3. Aaron, Castranova, and DPM knew that most of SMFF's excess cash was being swept into RCM and thus exposed to loss. They also knew that innocents at PlusFunds were unaware that the excess cash was unprotected. FAC ¶ 153.
4. The First Amended Complaint alleges that Aaron signed a letter on behalf of SPhinX that allowed SMFF excess cash at Refco LLC to be transferred to RCM. FAC ¶¶ 130–132. But the Plaintiffs have since backed off from that allegation. The Plaintiffs now concede that the so-called “Aaron letter” does not authorize the transfer of excess cash to RCM. See Plaintiffs' Memorandum in Opposition to Motion to Dismiss by DPM Defendants at 27; Transcript of Oral Argument at 114, Statement of Plaintiffs' counsel (“When you read the letter it was for margin money, it was not what would go to RCM”). The Plaintiffs still assert, however that Aaron failed to assure the segregation of SMFF's excess cash. FAC ¶ 249; Transcript of Oral Argument at 115 ().
5. Each of the Defendants authorized and facilitated the movement of SMFF cash to unprotected accounts at RCM. FAC ¶¶ 270–71.
6. DPM in its weekly risk reports misstated and/or omitted the fact that SMFF excess cash was at risk in unprotected accounts. See, e.g., FAC ¶ 337. Also, various statements in SPhinX offering memoranda, marketing materials, and financial statements misrepresented the fact that the excess cash was at risk and Aaron, Castranova and DPM helped to prepare all of these materials. FAC ¶¶ 380–388.
7. Mellon exercised control over DPM–Mellon, promised to bring...
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