Refco's Court Struggles Continue In New York

by Glen Shapiro, LawAndTax-News.com, New York

21 February 2006

Judge Robert D. Drain of the US Bankruptcy Court of the Southern District of New York last week heard submissions from both sides on the issue of whether Bermuda-based Refco Capital Markets should be forced into Chapter 7 liquidation.

A group of creditors, including Moscow-registered VR Partners Global hedge fund, argue that they are entitled to reclaim their assets, which they stand a better chance of achieving in a court-supervised Chapter 7 process than while Refco continues to manage its remaining subsidiaries in Chapter 11. VR Partners had placed more than US$700m worth of securities with Refco, and claims that these were customer assets which Refco illegitimately lent out to support non-VR deals.

A number of other creditors, including Bank of America and Wells Fargo, representing investors for whom they acted in providing finance to the unit, are opposing the conversion, as does Refco itself, saying that all creditors should be treated equally.

Lawyers for VR Global, Inter Financial Services and other pro-liquidation customers accuse Refco of misrepresenting how it would treat cash and securities in customer accounts. Sometimes, the judge was told, securities the customers had deposited in their accounts were not available to execute the trade because “they were loaned out.”

Richard Deitz, president of VR Capital Group, said in court that his Moscow-based hedge fund believed that Refco would not borrow against VR's assets, unless the fund itself borrowed against the assets. "It would be a completely different business model from what we understood they were doing," Deitz said.

Refco's lawyers countered that Refco Capital Markets customers were sophisticated investors buying esoteric securities, and chose to deal with an unregulated offshore dealer in order to gain benefits like better financing terms.

Refco Capital Markets is thought to owe customers nearly $4.2 billion. A second Bermuda-based unit, Refco Global Finance, is also involved in the bankruptcy proceedings. Previous hearings have been told that the exact financial state of Refco Capital Markets depends largely on its ability to recoup debts it is owed it by other Refco companies.

The plaintiff creditors said that Refco Capital Markets was a fraudulent operation: "The evidence will show that this is not a legitimate company. This is a Ponzi scheme," Thomas Moloney, the customer group's lawyer, told the judge.

Anthony Clark, a lawyer representing Refco Capital, told the judge however that Moloney's suggestion was hyperbole.
"A minority of the clients of RCM are trying to step ahead of the majority and get paid first," he said.

Refco completed the sale of its main futures business to the UK's Man Group in December. Judge Robert Drain ruled that Refco's assets would be transferred free and clear of all claims and liens. Clients held $6.5 billion in futures accounts at Refco on 30th September, but this figure had dwindled to barely $2bn by the time of the sale. Man Group agreed to buy the main assets of the business for $323 million, but Refco valued the deal at more than $1 billion because it allows Refco to retain its net regulatory capital and make those assets available to creditors.

Refco was the fourth-largest US broker before it emerged on 10th October that a former chief executive, Phillip Bennett, had failed to report $430 million in debt. The company filed for bankruptcy protection within a week as clients withdrew more than $3 billion.

Refco owes $16.8 billion to creditors in the bankruptcy, but still has more than 20 affiliated businesses whose valuations are difficult to ascertain, of which the Capital Markets unit is one of the most valuable.

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