Corporate Governance

NASCAT Reacts to Court of Appeals Ruling in Refco Fraud Case (Full Text Follows...)

By Jim Hodgson

FEDERAL APPEALS COURT PANEL TOSSES INVESTOR CLAIMS AGAINST CONVICTED ENABLER OF REFCO, INC. FRAUD SCHEME;  SECOND CIRCUIT RULING REJECTS SEC?S POSITION IN DENYING REMEDY FOR DEFRAUDED SHAREHOLDERS AND BONDHOLDERS

Ruling Highlights Need for Congress to Restore Accountability to Investors for Those who Knowingly Aid and Abet Securities Fraud

WASHINGTON, DC, April 28, 2010 ? The National Association of Shareholder and Consumer Attorneys (NASCAT) expressed dismay with the April 27 decision in PIMCO Funds, et al v. Mayer Brown LLP, et al by a three-judge panel of the U.S. Court of Appeals for the Second Circuit, which continued a pattern of rigid and overly technical interpretations of investors? rights under the federal securities laws.  Indeed, the Court tossed the clearly meritorious claims brought by shareholders and bondholders of bankrupt Refco, Inc. against that derivatives dealers? outside counsel who has been criminally convicted of the fraud alleged by investors and is serving a seven year sentence in federal prison. 

?This disheartening decision rejects the common-sense approach taken by the U.S. Securities and Exchange Commission (SEC), one fully supported by the relevant statute, Section 10 of the Securities Exchange Act of 1934, that investors do have a right of action against these defendants.  Indeed, Section 10 refers generally to the prohibition of ?any manipulative or deceptive device or contrivance in contravention? to SEC rules, which go beyond personally uttering a misrepresentation and surely encompasses using others to knowingly make a false public statement.  Instead, the Second Circuit?s holding rendered the obvious merits of Refco?s investors? claims irrelevant.  Indeed, unnecessarily going beyond even the two Supreme Court decisions (Central Bank in 1994 and Stoneridge in 2008) that the lower court noted were ripe for legislative re-examination, the panel granted complete immunity from lawsuits to all those who knowingly engage in securities fraud unless they are publicly identified or publicly participate in the wrongdoing,? explained Ira Schochet, Esq., NASCAT?s President.

?The Second Circuit?s decision underscores the need for Congress to restore accountability to investors for all who knowingly enable securities fraud,? Mr. Schochet continued.  ?Senator Arlen Specter, a former prosecutor and senior Member of the Judiciary Committee and Chairman Barney Frank of the House Financial Services Committee have each sponsored legislation to restore the right of investors to take action against those who knowingly and substantially participate in securities fraud including gatekeepers such as accountants, lawyers and investment advisers, without whom many complex frauds such as the Refco and Lehman Brothers ?book cooking? scams and the unfolding alleged Goldman Sachs derivatives? based swindle could not have occurred.?   

The SEC had filed a friend of court brief with the Court of Appeals arguing that in cases such as Refco, so-called ?secondary actors? such as consulting accountants and attorneys can be held liable as a ?primary violator? of SEC Rule 10b-5?s bar against ?mak[ing]? false or misleading statements to investors if that person creates and then provides the false or misleading information to another person intending that it be put into a public statement.  A flexible reading of the statute, which in prior decades the Supreme Court encouraged, readily allows the words ?to make?, relating to a materially false statement, to carry that meaning (since the statute does not say ?to express? or ?to utter? or use similar more restrictive verbs.)   Nonetheless, the Second Circuit panel held that the ?secondary actor? must be the one who publicly states the false or misleading information even if the lawyer (as in Refco) designed the sham transactions that made the fraud possible and then wrote the false statements made by other violators to investors and the public.

The underlying lawsuit brought by Refco?s shareholders and bond holders alleged that Refco?s outside attorney and its law firm (Mayer Brown, LLP) designed and helped sell to counterparties sham transactions and falsified securities offering documents to cover-up hundreds of millions of dollars in losses by Refco, Inc.  Refco, the once global, publicly traded derivatives dealer, collapsed in 2005 when its cover-up of the devastating losses unraveled.  

Although the lower court judge recognized the merits of the Refco plaintiffs? suit, he cited the Supreme Court Central Bank and Stoneridge decisions as compelling the dismissal of the investors? class action.  Since the lower court ruled, one of the defendants in that lawsuit, Joseph P. Collins, a partner at the law firm of Mayer Brown, and a former Refco legal adviser, has been convicted in a federal court of conspiracy to commit securities fraud and four other counts of illegal actions and is serving a seven year prison sentence.  Two others have pled guilty to fraud charges in this case.

?Private investors form a key front-line defense against financial fraud and abuse because they are in a unique position to quickly identify and take action against unlawful conduct by corporate issuers and their advisers,? Mr. Schochet continued.  ?Traditionally, securities market regulation and law enforcement relied upon a ?three legged stool? of the SEC, federal and state attorneys general and investor actions. In recent years, however, two legs of the regulatory stool were weakened by laxity in enforcement of federal securities law and Supreme Court decisions, and lower court rulings interpreting those decisions, which have curtailed investors? rights of action.  By immunizing fraud enablers from accountability to investors, the Courts have unwittingly encouraged  unscrupulous corporate lawyers, accountants and other gatekeepers to profit from wrongdoing.?

The National Association of Shareholder and Consumer Law Attorneys is a nonprofit organization comprised of about 100 law firms representing consumers and investors - including pension funds and individuals - in cases of securities fraud and other forms of "white collar" wrongdoing and criminal activity.

Full post as published by PomTalk on April 29, 2010 (boomark / email).