Clarification Sought in Refco Trustee’s Fraud Suit

(CN) - The 2nd Circuit asked New York's highest appeals court to decide whether the trustee for the now-bankrupt Refco and affiliates can sue third parties for allegedly helping corporate insiders defraud the company's creditors.

Refco was one of the world's largest providers of brokerage and clearing services in global derivatives, currency and futures markets before its 2005 collapse.

Marc Kirschner, as trustee for the company's litigation trust, sued a number of corporate advisors and insiders in May 2009, including several professional firms and former employees.

He said they created a "complex fraudulent scheme" to hide the company's true financial status and create the illusion of stability, so that insiders could exploit Refco's 2004 leveraged buyout by cashing out their interests on lucrative terms.

The scheme, Kirschner said, involved concealing hundreds of millions of dollars in uncollectable debt through bogus third-party loans. Refco insiders allegedly converted the uncollectable debt into money owed to Refco. They then made the receivables "disappear" through a series of so-called "round-trip loans," according to Kirschner.

He said the loans took place in the books only; the principal never changed hands.

U.S. District Judge Gerald Lynch summarized the allegations in his decision to dismiss the case for lack of standing:

"The net effect of these transactions was that at the close of each reporting period, Refco's books would show apparently legitimate loans to third-party customers, and the (uncollectable) receivables would be gone," he wrote.

"Through these transactions, Refco lent money to itself, through third parties, to conceal its trading losses, its true operating expenses, and the fictitious nature of hundreds of millions of dollars in revenue."

Lynch dismissed the case, saying the allegations against Refco insiders were imputed -- or attributed -- to the company itself.

"[T]he Trustee must allege, not that the insiders intended to ... benefit from their scheme, but that the corporation was harmed by the scheme, rather than being one of its beneficiaries," Lynch wrote, noting that Kirschner's complaint was "saturated by allegations that Refco received substantial benefits from the insiders' alleged wrongdoing."

On appeal, Kirschner argued that the "adverse interest exception" allows him to sue on Refco's behalf, because the corporate insiders had acted in their own interests, not the company's.

The Manhattan-based appeals court noted that "considerable uncertainty exists" on the issues of imputation and the adverse interest exception.

As a result, the court certified several questions to the New York Court of Appeals regarding the applicability of the exception in this case.

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