Customers of Bermuda’s now defunct Refco Capital Markets Ltd. who claimed principals at the firm violated US securities laws have lost their bid to recover monetary damages.
The US Court of Appeals for the Second Circuit yesterday [Jan. 10] found investors failed to allege deceptive conduct by the principals because the investors knew what they were getting into when they signed a standard agreement allowing Refco Capital Markets to “rehypothecate” — or otherwise use securities and other property held in customer brokerage accounts to secure margin trading.
The New York-based Second Circuit made that ruling in Capital Management Select Fund Ltd. v. Bennett, 08-6166-cv, and upheld the dismissal of consolidated cases seeking recompense from the principals of Refco Capital Markets, a Bermuda-based subsidiary of the now-bankrupt Refco Inc.
“On review of the customer agreement, we conclude that it unambiguously warned Refco Capital Markets customers that Refco Capital Markets intended to exercise full rehypothecation rights as to the customers’ excess margin securities,” Judge Ralph K. Winter wrote for the panel. He was joined by Judge Rosemary S. Pooler. Southern District Judge Jed Rakoff, sitting by designation, recused himself.
Refco and its affiliates filed for bankruptcy on October 17, 2005, after a “run on the bank” was caused by revelations that it had used “round-robin” loans to hide uncollected receivables from investor scrutiny.
In a December 30, 2005, filing, it was revealed the financial services company owed its customers some $4.16 billion and held only $1.905 billion in assets.
Since Refco Capital Markets was incorporated as an “exempt” company in Bermuda, it was unregulated in either the US or Bermuda, which opened the door for the company to conceal bad debts and finance risky investments.
Several people were charged criminally in the case, including former Refco chief executive Phillip R. Bennett and former senior executive Tome N. Grant, who are both serving prison terms for their role in the scandal.
“These unregulated entities are opaque to the US government,” said Michael Greenberger, a University of Maryland law professor and former head of trading and markets at the Commodities Futures Trading Commission said at the time of Refco’s collapse. “Because there is no handle on them here or in any of the other major financial centres, it’s just that much easier to commit fraud.”