Refco Litigation Trusts seek $2 billion in damages for advisers' alleged role in insider corruption

By Caroline Salls

Pittsburgh, Aug. 21 - The Refco Litigation Trusts filed a $2 billion lawsuit charging that Refco Inc.'s legal, accounting and financial advisers with knowingly assisting corrupt Refco insiders in looting Refco's assets, according to a trust news release.

The lawsuit, filed in the Circuit Court of Cook County, Illinois, names Mayer, Brown, Rowe & Maw LLP, Grant Thornton LLP, Ernst & Young LLP, PricewaterhouseCoopers, Credit Suisse Securities (USA), Banc of America, Deutsche Bank Securities, some Refco loan participants and the "corrupt Refco insiders" as defendants.

The trusts said the lawsuit seeks more than $2 billion in damages and penalties for the defendants' role in committing and aiding in the corrupt Refco insiders' fraud and breaches of fiduciary duty, and the lawsuit "provides a thorough description of the more than seven-year conspiracy to conceal Refco's trading losses, true operating expenses, marginal performance and theft of assets belonging to Refco's unregulated broker-dealer, Refco Capital Markets, Ltd."

According to the release, the lawsuit alleges that Refco's fraudulent scheme "only could have worked with the active assistance of Refco's cadre of outside auditors, professionals and advisers," which the trusts called "a veritable who's who of some of the most trusted names in corporate finance, law and accounting, whose reputations and substantial assistance aided the Refco insiders in stripping out billions of dollars in Refco assets."

The trusts alleged in their complaint that the fraud occurred in three phases.

First, the corrupt insiders, with the active assistance of its professional advisers, allegedly created the illusion that Refco was a successful and financially sound company; second, the defendants worked to maintain that illusion, allegedly "employing various financial chicanery to fool the outside world"; and third, the professional defendants allegedly orchestrated a massive cash-out, through which they aided the insiders in cashing out, "while at the same time lining their own pockets with substantial professional fees." The trusts alleged that the purpose of the entire scheme was to allow the Refco's insiders to sell their interests at fraudulently inflated prices.

"This is the second lawsuit filed by the Refco Litigation Trusts, which have a broad mandate to pursue claims on behalf of Refco and its creditors and are committed to achieving a full and speedy recovery of the massive damages caused to Refco by numerous parties," trustee Marc S. Kirschner said in the release.

Lawsuit allegations

Specifically, the lawsuit alleges that:

• Grant Thornton blessed Refco's financial statements "despite knowing the nature and massive extent of the fraud";

• Mayer Brown structured and documented fraudulent round-trip loan transactions at the end of every relevant reporting and auditing period and the unwinding of those transactions days later that were "like a street-corner shell game" solely designed to conceal trading losses and inflated expenses;

• Ernst & Young "willingly generated Refco's false tax returns," had complete knowledge of the scheme and helped the Refco insiders hide Refco's bad debts, acknowledging internally that it could be "an accessory to some type of fraud";

• PricewaterhouseCoopers wrongfully validated deficient internal controls and, with knowledge of the fraudulent round-trip loan transactions, falsified Refco's registration statements;

• The investment banker defendants "structured and facilitated the lucrative cashing-out" of the insiders' interests, knowing the extraordinary harm caused to Refco Capital Markets and its customers.

The lawsuit also alleges that the investment banks never trusted the insiders, "could not recreate management's projected free cash flows" and knew Refco Capital Markets' customer securities and cash were being used by Refco without the ability to repay Refco Capital Markets. The lawsuit alleges that this fact was not disclosed in Refco's public offering documents;

• One of the underwriter defendants commented internally that it viewed Refco's chief financial officer as a "pathological liar," yet it proceeded with a leveraged buyout and an initial public offering because of the enormous investment banking fees;

• Grant Thornton, Mayer Brown and PricewaterhouseCoopers participated in "conscious editing of SEC disclosure documents to conceal" a massive related-party receivable owed to Refco by a company controlled by the insiders;

• Participants in the round-trip loan transactions were well aware that they were involved in a scheme to prop up Refco's financial condition by making multi-hundred million dollar loans to a Refco-related party using Refco's own money to fund the loan.

The trusts alleged that the loan amounted to no more than a book-entry, for which the participant received a payment for agreeing to be a part of the scheme; and

• The Refco insiders stole securities and cash that were entrusted to Refco Capital Markets by its customers, without documentation, with no ability or intent to repay those diverted assets, and with no compensation to Refco Capital Markets, leaving Refco Capital Markets with more than $2 billion in uncollectible IOUs.

Refco, a New York-based commodities brokerage company, emerged from Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Southern District of New York on Dec. 26, 2006. The trusts were created under Refco's plan of liquidation.

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