From the October 01, 2007 issue of Futures Magazine • Subscribe!

Refco trustee brings suits

Though more than two years old, the Refco bankruptcy still has players fighting over blame and cash. In a lawsuit seeking more than $2 billion in damages and penalties from Refco auditor Grant Thornton LLP (GT), law firm Mayer Brown LLP (MB) and 24 other defendants, Refco Litigation Trustee Marc. S. Kirschner claims that Refco insiders were aided and abetted by a “who’s who” list of the world’s largest corporate finance, law and accounting firms “to strip out billions of dollars in Refco assets” in a three part scheme to create the illusion of financial health, maintain that illusion and cash-out their interests.

In court documents, Kirschner says that MB worked with Refco lawyers to “fraudulently bolster Refco’s financial appearance to lenders and investors,” through a series of round-trip loans (RTL) that served no purpose but to conceal hundreds of millions of dollars in receivables, a process he likens to a street corner shell game.

“It was shocking that this relatively crude scheme of making two-day loans without any risk, and earning a fee for it, first had takers; and second, perpetuated the fraud for seven, eight years,” Kirschner says. “We are seeking recompense because of it.”

Kirschner says Refco insiders masked trading losses as receivables owed by Refco Group Holdings Inc. (RGHI), which was owned by then CEO Phillip R. Bennett and Tone Grant, and had assets consisting of Refco stock. At the end of reporting and audit periods, Refco Capital Management (RCM) would loan as much as $720 million to a third party, which would then loan the same amount to RGHI, usually through a transfer to an RGHI account at Refco. RGHI completed the RTL when it used the third-party loan to pay off the debt owed to Refco.

The fraudulent transactions could not have been executed without the knowledge and involvement of those third parties, which were paid on the spread between the two loans, Kirschner says. Those parties include: Liberty Corner Capital Strategies LLC, EMF Financial, EMF Core Fund, Delta Flyer Fund LLC, Eric M. Flanagan, Ingram Micro Inc., CIM Ventures Inc., Beckenham Trading Co. Inc., Andrew Krieger, Coast Asset Management LLC, CS Land Management LLC, Christopher Petitt and William T. Pigott.

In addition, Kirschner says Credit Suisse, BAS and Deutsche recognized that a leveraged buyout by Thomas H. Lee Partners LLP (THL) would leave intercompany IOUs unpaid and unrecoverable while facilitating a fat payday for the Refco Insiders.

“Instead of owning up to Refco’s true financial condition and borrowing the money they needed as part of an overall restructuring of Refco’s operations, the Refco Insiders stole it from RCM and its customers,” the suit says, and when Refco later filed for bankruptcy, the total uncollectible RCM transfers were more than $2 billion. Refco Group Ltd. claimed only $515 million in capital in 2002, $566 million in 2003, $616 million in 2004 and $150 million in 2005.

Further, the suit alleges Ernst & Young LLP “willingly created false tax returns” and PricewaterhouseCoopers “validated Refco’s deficient internal controls” during the leveraged buyout by THL and through the initial public offering that preceded Refco’s collapse.

“Refco perpetrated a fraud which both benefited themselves and ultimately brought about their own downfall,” says a spokesperson for GT. “This suit brought against almost all of its former advisors is merely an attempt to avoid the consequences of its own actions and seek both scapegoats and deep pockets.”

In separate developments, Kirschner brought a suit to recover half a billion dollars to cover RCM customer losses against Refco officers, MB, GT and Ernst & Young alleging that RCM FX customer accounts were siphoned to finance other Refco business, dress up Refco’s finances and enrich Refco officers. THL has filed similar suits to recover $245 million from MB and $245 million from GT. In addition, Kirschner filed suit against THL and its directors alleging that they knew Refco’s financial statements were false and in need of correction. Through Refco’s LBO and IPO, THL and its directors made $275 million, according to the suit.

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