Refco Can’t Sue Insiders|for Assisting in Fraud

(CN) - The trustee of the Refco litigation trust cannot sue corporate insiders and advisers for misconduct because Refco itself had a hand in the fraud, the 2nd Circuit ruled.

U.S. District Judge Gerard Lynch had dismissed the claim of the trustee, Marc Kirschner, but Kirschner argued on appeal that the the adverse interest exception to imputation applies because the insiders abandoned Refco's interests while committing misconduct.

Circuit Judge Jon Newman explained in his ruling for the court that if corporate insiders' actions can be imputed to the corporation, then a trustee for a debtor corporation does not have standing to recover against third parties for damage to the creditors.

When Refco announced that its CEO Phillip Bennett had covered up $430 million in debts from shareholders, the company went bankrupt. Refco executives had engineered a fraudulent leveraged buyout in 2004 and an initial public offering in 2005 by concealing hundreds of millions of dollars in trading losses and padding the company's revenues.

Kirschner sued Refco senior management, law firms and accounting firms - including Pricewaterhousecoopers, Bank of America Securities, Credit Suisse Securities and Deutsche Bank Securities - that allegedly participated in defrauding Refco's creditors.

Newman wrote that the three-judge circuit court panel was uncertain about how New York law considers the adverse interest exception, and it certified questions on the issue to the New York Court of Appeals.

Any harm to a Refco entity ultimately helped the overall Refco fraud, Newman wrote.

The state appeals court informed the 2nd Circuit that the exception is only available when the insiders' misconduct has harmed the corporation.

"Judge Lynch correctly understood New York law in reaching his decision to dismiss the trustee's suit," Newman wrote. "With respect to all of the trustee's contentions challenging other aspects of Judge Lynch's decision, we conclude that he correctly rejected the trustee's arguments, and we adopt his opinion as the resolution of this appeal."

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