Capital Mgmt Select Fund Ltd., et al. v. Bennett et al., No. 08-6166 (2d Cir. 2012)
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Former customers of RCM, a subsidiary of the now-bankrupt Refco, appealed from a dismissal of their securities fraud claims against former corporate officers of Refco and Refco's former auditor. RCM operated as a securities and foreign exchange broker that traded in over-the-counter derivatives and other financial products on behalf of its clients. Appellants, investment companies and members of the putative class, claimed that appellees, former officers and directors of Refco, breached the agreements with the RCM customers when they rehypothecated or otherwise used securities and other property held in customer brokerage accounts. The district court dismissed the claims for lack of standing and failure to allege deceptive conduct. The court held that appellants have no remedy under the securities laws because, even assuming they have standing, they failed to make sufficient allegations that their agreements with RCM misled them or that RCM did not intend to comply with those agreements at the time of contracting.
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08-6166-cv(L) Capital Management Select Fund Ltd., et al. v. Bennett et al. 1 UNITED STATES COURT OF APPEALS 2 FOR THE SECOND CIRCUIT 3 August Term, 2009 4 5 6 7 8 9 10 11 12 13 14 15 16 17 (Argued: October 19, 2009 Docket Nos. Decided: January 10, 2012) 08-6166-cv(L) 08-6167-cv (Con) 08-6230-cv (Con) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - CAPITAL MANAGEMENT SELECT FUND LTD., INVESTMENT & DEVELOPMENT FINANCE CORPORATION, IDC FINANCIAL S.A., GLOBAL MANAGEMENT WORLDWIDE LIMITED, individually and on behalf of all others similarly situated, ARBAT EQUITY ARBITRAGE FUND LIMITED, RUSSIAN INVESTORS SECURITIES LIMITED, VR GLOBAL PARTNERS, L.P., PATON HOLDINGS, LTD., VR CAPITAL GROUP LTD., and VR ARGENTINA RECOVERY FUND LTD., Plaintiffs-Appellants, v. 18 19 20 21 22 PHILLIP R. BENNETT, PHILIP SILVERMAN, ROBERT C. TROSTEN, RICHARD N. OUTRIDGE, SANTO C. MAGGIO, LEO R. BREITMAN, GRANT THORNTON LLP, TONE N. GRANT, and REFCO GROUP HOLDINGS, INC., 23 24 25 26 27 28 29 30 31 32 33 34 35 JOSEPH J. MURPHY, RONALD O KELLEY, NATHAN GANTCHER, DENNIS A. KLEJNA, PERRY ROTKOWITZ, CREDIT SUISSE GROUP, CREDIT SUISSE FIRST BOSTON, GOLDMAN SACHS GROUP, INC., GOLDMAN SACHS & CO., BANK OF AMERICA SECURITIES, LLC, BANK OF AMERICA CORP, MERRILL LYNCH & CO, MERRILL LYNCH PIERCE, FENNER & SMITH INCORPORATED, JP MORGAN CHASE & CO, JP MORGAN SECURITIES, INC., SANDLER O NEIL & PARTNERS, L.P., HSBC HOLDINGS, PLC, HSBC SECURITIES {USA} INC., WILLIAM BLAIR & COMPANY, LLC, HARRIS NESBITT CORP., CMG INSTITUTIONAL TRADING, LLC, SAMUEL A. RAMIREZ & CO., INC., THE WILLIAMS CAPITAL GROUP, L.P., UTENDAHL CAPITAL PARTNERS, L.P., REFCO SECURITIES, LLC, THL ENTITIES, Defendants-Appellees, Defendants, 1 1 2 3 4 5 6 7 8 9 10 BANK FUR ARBEIT UND WIRTSCHAFT UND OSTERREICHISCHE POSTPARKASSE AKTIENGESELLSEHAFT, GERALD M. SHERER, WILLIAM M. SEXTON, THOMAS H. LEE PARTNERS, LP, THOMAS H. LEE ADVISORS, LLC, THL MANAGERS V, L.L.C., THL EQUITY ADVISORS V, LLP, THOMAS H. LEE EQUITY FUND V, L.P., THOMAS H. LEE PARALLEL FUND V, LP, THOMAS H. LEE EQUITY (CAYMAN) FUND V, LP, THOMAS H. LEE INVESTORS LIMITED PARTNERSHIP, 1997 THOMAS H. LEE NOMINEE TRUST, THOMAS H. LEE, DAVID V. HARKINS, SCOTT L. JAECKEL, SCOTT A. SCHOEN, 11 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 12 B e f o r e: Consolidated-Defendants. 13 WINTER and POOLER, Circuit Judges.* Appeal from an order entered by the United States District 14 Court for the Southern District of New York (Gerard E. Lynch, 15 Judge), dismissing plaintiffs claims under Section 10(b) for 16 failure to plead deceptive conduct. 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 We affirm. SCOTT A. EDELMAN (Sander Bak & Michael Shepherd, on the brief), Milbank, Tweed, Hadley & McCloy LLP, New York, New York, for Plaintiffs-Appellants; Co-Lead Counsel for Lead Plaintiffs and the Putative Class. Richard L. Stone (Mark A. Strauss, on the brief), Kirby McInerney & Squire LLP, New York, New York, for PlaintiffsAppellants; Co-Lead Counsel for Lead Plaintiffs and the Putative Class. Claire P. Gutekunst, Jessica Mastrogiovanni, and Jed Friedman, * This panel originally included the Honorable Jed S. Rakoff, United States District Judge for the Southern District of New York, sitting by designation; however, Judge Rakoff has recused himself. Therefore, this case is decided by the remaining judges in accordance with Second Circuit Internal Operating Procedure E(b). 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 Proskauer Rose, LLP, New York, New York, for Defendant-Appellee Richard N. Outridge. Barbara Moses, Judith L. Mogul, and Rachel Korenblat, Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C., New York, New York, for Defendant-Appellee Robert C. Trosten. Stuart I. Friedman, Ivan Kline, and Jonathan Daugherty, Friedman & Wittenstein P.C., New York, New York, for Defendant-Appellee William M. Sexton. LINDA T. COBERLY and Bruce R. Braun, Winston & Strawn LLP, Chicago, Illinois, for DefendantAppellee Grant Thornton LLP. Laura E. Neish, Zuckerman Spaeder LLP, New York, New York, for Defendant-Appellee Tone N. Grant. David V. Kirby, Krantz & Berman, LLP, New York, New York, for Defendant-Appellee Philip Silverman. Susan S. McDonald, Jacob H. Stillman, Mark D. Cahn, and David M. Becker, Securities and Exchange Commission, Washington, D.C., for Amicus Curiae Securites and Exchange Commission. RICHARD A. ROSEN (Walter Rieman, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, New York; Greg A. Danilow, on the brief, Weil Gotshal & Manges LLP, New York, New York, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, New York, for Defendants THL Partners. 3 1 WINTER, Circuit Judge: 2 Former customers ( RCM Customers ) of Refco Capital 3 Markets, Ltd. ( RCM ), a subsidiary of the now-bankrupt Refco, 4 Inc., appeal from Judge Lynch s dismissal of their Section 5 10(b) securities fraud claims against former corporate officers 6 of Refco and Refco s former auditor, Grant Thornton LLP.1 7 Appellants claim that appellees breached the agreements with 8 the RCM Customers when they rehypothecated or otherwise used 9 securities and other property held in customer brokerage 10 accounts. 11 The district court dismissed the claims for lack of 12 standing and failure to allege deceptive conduct, see In re 13 Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., No. 14 06 Civ. 643, 2007 WL 2694469 (S.D.N.Y. Sept. 13, 2007) ( RCM 15 I ); In re Refco Capital Mkts., Ltd. Brokerage Customer Sec. 16 Litig., 586 F. Supp. 2d 172 (S.D.N.Y. 2008) ( RCM II ); In re 17 Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., Nos. 18 06 Civ. 643, 07 Civ. 8686, 07 Civ. 8688, 2008 WL 4962985 19 (S.D.N.Y. Nov. 20, 2008) ( RCM III ) (on a motion for 20 reconsideration). 21 We hold that appellants have no remedy under the 22 securities laws because, even assuming they have standing, they 23 fail to make sufficient allegations that their agreements with 1 A group of defendants associated with Thomas H. Lee Partners, L.P., a private equity firm that at relevant times held a majority interest in Refco (the THL Defendants ) were also appellees; however, the appeal against those parties is hereby dismissed pursuant to a joint stipulation. 4 1 RCM misled them or that RCM did not intend to comply with those 2 agreements at the time of contracting. We therefore affirm. 3 BACKGROUND 4 On an appeal from a grant of a motion to dismiss, we 5 review de novo the decision of the district court. See Staehr 6 v. Hartford Fin. Servs. Group, 547 F.3d 406, 424 (2d Cir. 7 2008). 8 factual allegations in the complaint as true, and drawing all 9 reasonable inferences in the plaintiff s favor. We construe the complaint liberally, accepting all Chambers v. 10 Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002). 11 survive a motion to dismiss, however, a complaint must allege a 12 plausible set of facts sufficient to raise a right to relief 13 above the speculative level. 14 57 (2d Cir. 2011). 15 a) S.E.C. v. Gabelli, 653 F.3d 49, The Parties and Their Businesses 16 17 To Capital Management Select Fund Limited and other named appellants2 are investment companies, which, along with members 2 This appeal arises from three separate actions that were consolidated at the pretrial phase: RCM I, 2007 WL 2694469 (S.D.N.Y. Sept. 13, 2007) (the Class Action ); VR Global Partners, L.P. et al. v. Bennett et al., No. 07 Civ. 8686, 2007 WL 4827764 (S.D.N.Y. filed Oct. 9, 2007) (the VR Action ; and Capital Management Select Fund Ltd. v. Bennett, No. 07 Civ. 8688, 2007 WL 4837768 (S.D.N.Y. filed Oct. 9, 2007) (the Capital Management Action ). Lead plaintiffs in the original Class Action are Global Management Worldwide Ltd., Arbat Equity Arbitrage Fund Ltd., and Russian Investors Securities Ltd. All three lead plaintiffs in the Class Action are commonly controlled investment funds. Plaintiffs in the VR Action are VR Global Partners, L.P., Paton Holdings Ltd., VR Capital Group Ltd., and VR Argentina Recovery Fund, Ltd. (collectively VR Plaintiffs ). In their complaint, VR Plaintiffs describe themselves as private investment funds, each of which operates as either a limited liability partnership or limited liability company registered in Grand Cayman. Plaintiffs in the Capital Management Action are Capital Management Select Fund Ltd., Investment & Development Finance Corporation, and IDC Financial S.A. Capital Management is an investment company incorporated under 5 1 of the putative class, held assets in securities brokerage 2 accounts with RCM. 3 subsidiaries of the now-bankrupt Refco, a publicly traded 4 holding company that, through its operating subsidiaries, 5 provided trading, prime brokerage, and other exchange services 6 to traders and investors in the fixed income and foreign 7 exchange markets. 8 directors of Refco and/or its affiliates (the Refco Officer 9 Defendants ), and Refco s former auditor, Grant Thornton, LLP. 10 RCM is one of three principal operating Appellees are various former officers and RCM operated as a securities and foreign exchange broker 11 that traded in over-the-counter derivatives and other financial 12 products on behalf of its clients. 13 under the laws of Bermuda and represented itself as a Bermuda 14 corporation, it operated from New York at all relevant times. 15 These operations were under the leadership of, and through a 16 sales force of account officers and brokers employed by, its 17 affiliated corporation, Refco Securities, LLC, ( RSL ), a 18 wholly-owned subsidiary of Refco that operated as a U.S.-based 19 broker-dealer registered with the SEC. 20 b) 21 22 Although RCM was organized Brokerage Account Customer Agreements RCM Customers held securities and other assets in non- discretionary securities brokerage accounts with RCM pursuant the laws of the Bahamas. Investment & Development Finance is an investment company incorporated under the laws of the British Virgin Islands. IDC Financial is an investment company incorporated under the laws of Panama. 6 1 to a standard form Securities Account Customer Agreement with 2 RCM and RSL (the Customer Agreement ). 3 securities and other property deposited in their accounts were 4 not segregated but were commingled in a fungible pool. 5 result, no particular security or securities could be 6 identified as being held for any particular customer. 7 practice is common in the brokerage industry. 8 PaineWebber, Inc., 159 F.3d 698, 701 (2d Cir. 1998) ( Customer 9 accounts with brokers are generally not segregated, e.g. in RCM Customers As a Such a See Levitin v. 10 trust accounts. 11 reserves of the broker. ); U.C.C. § 8-503 cmt. 1 ( [S]ecurities 12 intermediaries generally do not segregate securities in such 13 fashion that one could identify particular securities as the 14 ones held for customers. ); Adoption of Rule 15c3-2 Under the 15 Securities Exchange Act of 1934, Exchange Act Release No. 34- 16 7325, 1964 WL 68010, *1 (1964) ( [W]hen [customers of broker- 17 dealers] leave free credit balances with a broker-dealer the 18 funds generally are not segregated and held for the customer, 19 but are commingled with other assets of the broker-dealer and 20 used in the operation of the business. ). 21 Rather, they are part of the general cash The Customer Agreement included a margin provision that 22 permitted RCM Customers to finance their investment 23 transactions by posting securities and other acceptable 24 property held in their accounts as collateral for margin loans 25 extended by RCM. Under the margin provision, RCM, upon 7 1 extending a margin loan to a customer, had the right to use or 2 rehypothecate 3 the customer s account securities and other 3 property for RCM s own financing purposes. 4 might pledge customers securities as collateral for its own 5 bank loans or sell the securities pursuant to repurchase 6 agreements ( repos ).4 7 rehypothecation rights were limited to securities serving as 8 collateral or whether they also included securities that were 9 excess collateral. 10 For example, RCM The parties dispute whether the We discuss this dispute, infra. We briefly provide a generic background. From an ex ante 11 perspective, such margin provisions provide distinct, but 12 related, economic benefits to both the brokerage and its 13 customers. 14 the ability to invest on a leveraged basis and thereby earn 15 amplified returns on their investment capital. 16 brokerage, the ability to rehypothecate its customers 17 securities presents, among other things, an additional and 18 inexpensive source of secured financing. For the customers, the margin provision provides As for the See Michelle Price, 3 Rehypothecation technically refers to a broker s re-pledging of securities held in its customer s margin account as collateral for a bank loan. Similarly, a broker may sell the securities through a repurchase agreement, which is functionally equivalent to a secured loan. See infra Note 4. Hereinafter we will refer to rehypothecation in the general sense -- i.e., a broker s use and/or pledging of its customer s margin account securities to obtain financing for its own transactions. 4 A repurchase agreement is an agreement involving the simultaneous sale and future repurchase of an asset. In a typical repurchase agreement, the original seller buys back the asset at the same price at which he sold it, with the original seller paying the original buyer interest on the implicit loan created by the transaction. See In re Comark, 124 B.R. 806, 809 n.4 (Bankr. C.D. Cal. 1991). 8 1 Picking over the Lehman Carcass - Asset Recovery, Banker, Dec. 2 1, 2008, available at 2008 WLNR 24064913 ( [Without 3 rehypothecation rights] the prime broker would have to use its 4 unsecured credit facilities, the cost of which is currently in 5 the region of 225 to 300 basis points above that of secured 6 credit. ). 7 While these types of margin provisions provide economic 8 benefits to both parties, like any creditor-debtor arrangement 9 they also create counterparty risks. The brokerage bears the 10 risk that its customers default on margin loans that could 11 become under-secured due, for example, to a precipitous decline 12 in the value of the posted collateral. 13 the customers face the possibility that the brokerage, having 14 rehypothecated its customers securities, fails, making it 15 unable to return customer securities after those customers meet 16 their margin debt obligations. 17 Likewise, of course, Counterparty risks associated with margin financing have 18 long been recognized by industry participants and regulators 19 alike. In the United States, for example, margin financing has 9 1 been subject to federal5 and state6 regulation, and, even 2 longer still, to self-imposed limitations by brokers and self- 3 regulating organizations.7 4 attempt to reduce the counterparty risk associated with margin 5 financing by limiting the types of securities that can be 6 posted by an investor as collateral for a margin loan and 7 limiting the amounts that can be borrowed against that 8 collateral.8 In general, margin restrictions 9 Similarly, at least in the United States, brokers 10 rehypothecation activities have long been restricted by 11 federal9 and state law,10 and by rules promulgated by the 5 Federal regulation of margin financing for securities purchases was introduced in the 1913 Federal Reserve Act. See Board of Governors of the Federal Reserve System, A Review and Evaluation of Federal Margin Regulations 45 (1984). After the 1929 stock market crash, Congress imposed sweeping regulation of margin financing under the Exchange Act, 15 U.S.C. §§ 78a to 78hh-1. Statutory authority for regulating margin financing was granted under Section 7 of the Act. See id. § 78g. 6 State regulation of margin financing generally arises under Article 8 of the Uniform Commercial Code. 7 The New York Stock Exchange ( NYSE ) first established margin restrictions for exchange members in 1913 when it required its members to impose margin levels that were proper and adequate. See Board of Governors of the Federal Reserve System, supra, at 45. The NYSE currently restricts customer margin levels under NYSE Rule 431 which, inter alia, limits the amount of credit that can be used by a customer to purchase securities. See NYSE Rule 431, available at 2003 WL 25658590. 8 See, e.g., Federal Reserve Board Regulation T, 12 C.F.R. § 200.1 et seq. (imposing initial and maintenance margin requirements on investors purchasing securities on margin); see also Federal Reserve Board Regulation U, 12 C.F.R. § 221.1 et seq. (similar margin restrictions applicable to banks and other lenders); Federal Reserve Board Regulation X, 12 C.F.R. § 224.1 et seq., (similar margin restrictions applicable to margin loans not explicitly covered by other regulations). 9 The SEC first restricted brokers rehypothecation rights with the adoption of Rule 8c-1, 17 C.F.R. § 240.8c-1, and Rule 15c2-1, 17 C.F.R. § 240.15c2-1, in 1940. In general, these rules prohibit the following 10 1 principal stock exchanges.11 2 limit a broker s ability to commingle its customers securities 3 without their consent, and limit a broker s rehypothecation 4 rights with respect to a customer s excess margin securities 5 i.e., securities not deemed collateral to secure a customer s 6 outstanding margin debt, and fully-paid securities, i.e., 7 securities in a cash account for which full payment has been 8 made.12 9 These restrictions generally The upshot of these restrictions is that in the United 10 States, brokers and investors alike are limited in the amount 11 of leverage that is available to amplify returns. 12 since the development of globalized capital and credit markets, 13 investors have sought to avoid these limitations by seeking 14 unrestricted margin financing through, among other sources, 15 unregulated offshore entities. 16 Inc. v. Transamerica Corp., 303 F. Supp. 1354 (S.D.N.Y. 1969) However, See, e.g., Metro-Goldwyn-Mayer, activities without first obtaining consent from the customer: (i) commingling of the securities of different customers as collateral for a loan; (ii) commingling a customer s securities with its own under the same pledge; and (iii) pledging a customer s securities for more than the customer owes. See Statement of Commission Issued in Connection with the Adoption of Rules X-8C-1 and X-15-C2-1, Exchange Act Release No. 2690, 1940 WL 974 (1940). 10 See Report of Special Study of Securities Markets of the Securities and Exchange Commission, H.R. Doc. No. 88-95, pt. 1, at 406 (1963) (listing statutory hypothecation restrictions under the laws of Iowa, Michigan, Nebraska, and New York). 11 Id. at 405-07 (listing rehypothecation restriction rules of the various exchanges). 12 See, e.g., SEC Rule 15c3-3 (prohibiting a broker from rehypothecating an amount of customer s collateral in excess of 140 percent of the customer s outstanding margin debt), 17 C.F.R. § 240.15c3-3. 11 1 (leveraged buyout of Metro-Goldwyn-Mayer financed through the 2 Eurodollar market, thus avoiding U.S. margin restrictions); 3 Martin Lipton, Some Recent Innovations to Avoid the Margin 4 Regulations, 46 N.Y.U. L. Rev. 1 (1971). 5 U.S.-based broker-dealers have satisfied investor demand for 6 unrestricted margin financing by providing financing to 7 institutional investors, -- e.g., hedge funds -- through, inter 8 alia, unregulated foreign affiliates that are not subject to 9 U.S. margin or rehypothecation restrictions. In recent years, See Noah Melnick 10 et al., Prime Broker Insolvency Risk, Hedge Fund J., Nov. 2008 11 ( US prime brokers commonly rely on [foreign] unregulated 12 affiliates for margin lending or securities lending and/or to 13 act as custodians in non-US jurisdictions. ); Sherri Venokur & 14 Richard Bernstein, Protecting Collateral against Bank 15 Insolvency Risk--Part I, Sept. 8, 2008, at 1 ( U.S. registered 16 broker-dealers enter into derivatives transactions through 17 their unregulated affiliates in order to reduce capital reserve 18 requirements but also to be able to use counterparty 19 collateral. ); Roel C. Campos, SEC Comm r, Remarks before the 20 SIA Hedge Funds & Alternative Investments Conference (June 14, 21 2006) (noting that certain hedge fund financing is generally 22 booked through foreign, unregulated affiliates). 23 In the instant case, RCM held itself out as, and the 24 record indicates that at least some of the RCM Customers 25 understood it to be, an unregulated offshore broker. 12 1 2 c) The Lawsuit The event giving rise to this action is the collapse of 3 Refco, RCM s now-bankrupt parent corporation. On October 20, 4 2005, a little more than two months after issuing an initial 5 public offering of its stock, Refco announced a previously 6 undisclosed $430 million uncollectible receivable and disavowed 7 its financial statements for the previous three years. 8 uncollectible receivable stemmed, in part, from losses suffered 9 by Refco and several of its account holders during the late The 10 1990s. Rather than disclose its losses to the public and its 11 investors at that time, Refco s management devised and 12 implemented a round robin loan scheme to conceal the losses. 13 The first part of this scheme involved Refco transferring its 14 uncollectible receivables to the books of Refco Group Holdings, 15 Inc. ( RGHI ), an entity owned and controlled by appellee- 16 defendant Phillip R. Bennett, Refco s then-President, CEO, and 17 Chairman. 18 party nature of the RGHI receivable, a Refco entity (alleged by 19 plaintiffs typically to be RCM) would extend loans to multiple 20 unrelated third parties that would in turn lend the funds to 21 RGHI to pay down the uncollectible receivables. 22 manner, Refco effectively eliminated the uncollectible related- 23 party receivable from its books just prior to each relevant 24 financial period but would unwind the loans shortly thereafter. 25 The transactions allegedly took place over the course of six Then, in order to mask the magnitude and related- 13 In this 1 years, between 1998 and 2004, and were never disclosed in 2 Refco s public securities filings. 3 receivable had grown to an amount alleged to be in excess of $1 4 billion. 5 By 2004, the RGHI Prior to Refco s 2005 disclosure, beginning in late 2003, 6 THL, a private equity investment fund that focuses on the 7 acquisition of equity stakes in mid-to-large capitalization 8 companies, began exploring investment opportunities in Refco, 9 and ultimately completed a leveraged buyout in August 2004. 10 Following Refco s disclosure of its $430 million 11 uncollectible receivable, customers holding accounts with RCM, 12 including appellants, attempted to withdraw their assets from 13 RCM. 14 October 13, 2005, Refco announced a unilateral 15-day 15 moratorium on all RCM trading activities. 16 Refco, along with RCM and several other Refco affiliates, filed 17 for Chapter 11 bankruptcy protection in the Southern District 18 of New York. 19 disclosed that it owed its customers approximately $4.16 20 billion, while holding only $1.905 billion in assets. 21 22 This began the proverbial run on the bank, and, on On October 17, 2005, In a December 30, 2005 bankruptcy filing, RCM Along with a host of other plaintiffs who brought actions in the wake of Refco s collapse,13 on January 26, 2006, 13 See Am. Fin. Int l Group-Asia, L.L.C. v. Bennett, No. 05 Civ. 8988, 2007 WL 1732427 (S.D.N.Y. June 14, 2007); In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611 (S.D.N.Y. 2007); Thomas H. Lee Equity Fund V, L.P. v. Bennett, No. 05 Civ. 9608, 2007 WL 950133 (S.D.N.Y. Mar. 28, 2007); In re Refco, Inc., 14 1 plaintiff-appellant Global Management Worldwide Limited, an 2 investment fund organized under the laws of Bermuda, filed a 3 putative class action on behalf of all brokerage customers of 4 RCM who held securities with RCM and/or RSL between October 17, 5 2000 and October 17, 2005. 6 Management Worldwide filed a Consolidated Amended Class Action 7 Complaint, in which Arbat Equity Arbitrage Fund Limited and 8 Russian Investors Securities Limited, both commonly controlled 9 investment funds, were added as Co-Lead Plaintiffs of the On September 5, 2006, Global 10 putative class. The amended complaint named appellees as 11 defendants. 12 officers caused RCM to improperly sell or lend securities and 13 other assets from RCM Customers trading accounts to various 14 Refco affiliates in order to fund Refco s operations. 15 complaint further alleges that this practice was approved by, 16 and well known to, all members of Refco senior management. The complaint alleges that Refco s corporate The 17 On September 13, 2007, the district court dismissed the 18 putative class action suit for plaintiffs failure to allege 19 deceptive conduct. 20 replead as to certain defendants. 21 *12-13. 22 -- one group associated with investment fund VR Global 23 Partners, L.P., ( VR Plaintiffs ), and a second group However, it granted plaintiffs leave to RCM I, 2007 WL 2694469, at On October 9, 2007, two separate groups of plaintiffs No. 06 Civ. 1888, 2006 WL 1379616 (S.D.N.Y. May 16, 2006); In re SPhinX, Ltd., 371 B.R. 10 (S.D.N.Y. 2007). 15 1 associated with investment fund Capital Management Select Fund 2 Ltd. ( CM Plaintiffs ) - filed individual actions based on 3 allegations similar to those raised in the putative class 4 action complaint. 5 district court consolidated all three actions for pretrial 6 purposes, subsequent to which the lead plaintiffs in the 7 putative class action filed a Second Amended Complaint. 8 In the consolidated action, all plaintiffs alleged Thereafter, on November 20, 2007, the 9 violations of Sections 10(b) and 20(a) of the Exchange Act and 10 Rule 10b-5 against all Refco Officer Defendants, and violations 11 of Rule 10b-16 against all Refco Officer Defendants who, 12 together with RCM and Refco, allegedly extended margin credit 13 to RCM Customers without adequately disclosing RCM s use of 14 Customer securities. 15 and 20(a) of the Exchange Act); 17 C.F.R. §§ 240.10b-5, .10b-16 16 (Rules 10b-5 and 10b-16). 17 violations of Section 10(b) and Rule 10b-5 as against Grant 18 Thornton. 19 15 U.S.C. §§ 78j(b), 78l (Sections 10(b) In addition, VR Plaintiffs alleged On August 28, 2008, the district court granted motions to 20 dismiss filed by various Officer Defendants and Grant Thornton. 21 RCM II, 586 F. Supp. 2d at 174. 22 dismiss, the court rejected RCM Customers Section 10(b) claim 23 for lack of standing under the purchaser-seller rule of Blue 24 Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). 25 586 F. Supp. 2d at 178-81. In granting the motions to RCM II, As a separate ground for dismissal, 16 1 the court ruled that plaintiffs failed to adequately plead 2 deceptive conduct through any affirmative act or 3 misrepresentation, breach of fiduciary duty, or any other 4 manner. 5 Id. at 181-94. Finally, as to RCM Customers Section 20(a) claims, the 6 court concluded that because plaintiffs could not bring a claim 7 against any defendant for a primary violation of Section 10(b) 8 and Rules 10b-5 and 10b-16, plaintiffs necessarily lacked 9 standing to bring a controlling person action under Section 10 11 20(a). Id. at 195. In considering RCM Customers request for leave to 12 replead, the court first noted that all plaintiffs had the 13 benefit of filing their complaints after the court s September 14 13, 2007 Opinion and Order, which detailed the deficiencies in 15 the initial class-action pleading. 16 observed that VR Plaintiffs and CM Plaintiffs all had more than 17 adequate access to Refco s internal files, including books, 18 records, and corporate minutes, as a result of their 19 participation in the Refco bankruptcy proceeding. 20 no indication that RCM Customers could provide additional facts 21 to cure their pleading defects, the district court denied RCM 22 Customers request for leave to replead. 23 Id. at 196. The court also Id. Finding Id. On September 12, 2008, plaintiffs filed a motion to 24 reconsider the district court s denial of leave to replead. 25 their motion, RCM Customers asserted that, given the 17 In 1 opportunity to replead, they would be able to establish 2 deceptive conduct by showing that RCM improperly rehypothecated 3 the Customers fully-paid securities. 4 granted the motion for reconsideration but again denied RCM 5 Customers leave to replead. 6 court determined that even if RCM Customers could establish 7 deceptive conduct based on RCM s rehypothecation of fully-paid 8 securities, plaintiffs still had no standing as actual 9 purchaser[s] or seller[s] under Blue Chip Stamps. 10 The district court RCM III, 2008 WL 4962985. The Id. at *3. This appeal followed. 11 DISCUSSION 12 RCM Customers seek to recover under Section 10(b) of the 13 Exchange Act, 15 U.S.C. § 78j(b). 14 they were deceived by, inter alia, the terms of the Customer 15 Agreement and RCM s written Trade Confirmations, RCM s written 16 account statements, and oral representations by certain 17 appellees. 18 a) 19 RCM Customers assert that Section 10(b) We turn first to Section 10(b), which makes it unlawful to 20 use or employ, in connection with the purchase or sale of any 21 security . . . any manipulative or deceptive device or 22 contrivance in contravention of such rules and regulations as 23 the Commission may prescribe. 24 elements of a Section 10(b) claim are familiar to all federal 25 courts. 15 U.S.C. § 78j(b). The A plaintiff claiming fraud must allege scienter, a 18 1 mental state embracing intent to deceive, manipulate, or 2 defraud, Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 3 U.S. 308, 319 (2007) (quoting Ernst & Ernst v. Hochfelder, 425 4 U.S. 185, 193 n.12 (1976)), and must state with particularity 5 facts giving rise to a strong inference that the defendant 6 acted with the required state of mind. 7 4(b)(2). 8 than merely reasonable or permissible -- it must be cogent 9 and compelling, thus strong in light of other explanations. 15 U.S.C. § 78u- A strong inference of scienter is one that is more 10 Tellabs, 551 U.S. at 323-24. This strong inference of scienter 11 can be established by alleging either (1) that defendants had 12 the motive and opportunity to commit fraud, or (2) strong 13 circumstantial evidence of conscious misbehavior or 14 recklessness. 15 Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009). ECA & Local 134 IBEW Joint Pension Trust of 16 Although no claim for breach of contract is pursued by 17 appellants, the gravamen of their Section 10(b) claim is such a 18 breach. 19 of the securities laws. 20 801 (2d Cir. 2000) ( [T]he failure to carry out a promise made 21 in connection with a securities transaction is normally a 22 breach of contract and does not justify a Rule 10b-5 action 23 . . . unless, when the promise was made, the defendant secretly 24 intended not to perform or knew that he could not perform. 25 (citation and internal quotation marks omitted) (quoting Mills Breaches of contract generally fall outside the scope See Gurary v. Winehouse, 235 F.3d 792, 19 1 v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 2000))); 2 Desert Land, LLC v. Owens Fin. Grp., Inc., 154 Fed. App x. 586, 3 587 (9th Cir. 2005) ( [T]he mere allegation that a contractual 4 breach involved a security does not confer standing to assert a 5 10b-5 action. ). 6 However, although [c]ontractual breach, in and of itself, 7 does not bespeak fraud, Mills, 12 F.3d at 1176, it may 8 constitute fraud where the breaching party never intended to 9 perform its material obligations under the contract. See Cohen 10 v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994) ( The failure to 11 fulfill a promise to perform future acts is not ground for a 12 fraud action unless there existed an intent not to perform at 13 the time the promise was made. ). 14 under Section 10(b) if there are particularized allegations 15 that the contract itself was a misrepresentation, i.e., the 16 plaintiff s loss was caused by reliance upon the defendant s 17 specific promise to perform particular acts while never 18 intending to perform those acts. 19 United Int l Holdings, Inc., 532 U.S. 588 (2001) (defendant 20 violated Section 10(b) when it sold a security while never 21 intending to honor its agreement); Ouaknine v. MacFarlane, 897 22 F.2d 75, 81 (2d Cir. 1990) (Section 10(b) plaintiff adequately 23 alleged facts to imply the defendants intended to deceive when 24 they issued an offering memorandum); Luce v. Edelstein, 802 25 F.2d 49, 55-56 (2d Cir. 1986) (allowing Section 10(b) claim 20 Private actions may succeed See Wharf (Holdings) Ltd. v. 1 where plaintiff alleged defendant s promises made in 2 consideration for a sale of securities were known by defendant 3 to be false); cf. Mills, 12 F.3d at 1176 (denying Section 10(b) 4 claim because plaintiff alleged no facts probative of 5 defendant s intent at contract formation). 6 We have also held that where a breach of contract is the 7 basis for a Section 10(b) claim, the promise . . . must 8 encompass particular actions and be more than a generalized 9 promise to act as a faithful fiduciary. 10 Luce, 802 F.2d 55. With respect to the present action, we add that a simple 11 disagreement over the meaning of an ambiguous contract combined 12 with a conclusory allegation of intent to breach at the time of 13 execution will not do. 14 character that alone provides strong circumstantial evidence 15 of an intent to deceive at the time of contract formation, ECA, 16 553 F.3d at 198, or there must be allegations of particularized 17 facts supporting a cogent and compelling inference of that 18 intent, Tellabs, 551 U.S. at 324; Int l Fund Mgmt. S.A. v. 19 Citigroup Inc., Nos. 09 Civ. 8755, 10 Civ. 7202, 10 Civ. 9325, 20 11 Civ. 314, 2011 WL 4529640, at *9 (S.D.N.Y. Sept. 30, 2011). 21 In the present case, there are no particularized allegations of 22 fact supporting such an inference of deceptive intent at the 23 time of execution of the Customer Agreements. 24 requisite intent must be inferred, if at all, from the Customer 25 Agreement itself and the nature of the alleged breach. Either the alleged breach must be of a 21 Therefore, the 1 2 3 b) The Customer Agreement as a Misrepresentation 4 that their securities and other assets would be safeguarded, 5 and, in particular, that RCM would not rehypothecate excess 6 margin or fully-paid securities. 7 RCM routinely rehypothecated all of its customers securities, 8 regardless of the customers outstanding margin debt, and did 9 so from the start of each customer s account. RCM Customers claim that they were deceived into believing They allege that, in fact, The allegations 10 as to RCM s conduct are sufficient to satisfy the element of 11 intent at the time of contract formation. 12 issue, therefore, is whether RCM s rehypothecation of 13 securities even when they were not deemed collateral was so 14 inconsistent with the provisions of the Customer Agreement that 15 the Agreement was itself a deception.14 16 The crux of the Section B15 of the Customer Agreement establishes the 14 There is no issue regarding the financial sophistication of the RCM Customers. They are investment funds with access to the finest advisory resources. Indeed, all plaintiffs have alleged that, from the outset, they knew of, and were sensitive to, the counterparty risk associated with a broker-dealer s rehypothecation of its customers securities. 15 Section A of the Customer Agreement clearly indicates that RCM Customers accounts were non-discretionary. This section states, in relevant part: A. AUTHORIZATION 1. Authority to Act. You hereby authorize [RCM] to purchase, sell, borrow, lend, pledge or otherwise transfer Financial Instruments (including any interest therein) for your account in accordance with your oral or written instructions . . . Except to the extent you have expressly authorized someone else to buy, sell and otherwise effect Transactions on your behalf and for your account, all Transactions introduced to [RCM] by RSL on your behalf and entered into pursuant to this Agreement shall be initiated orally or in writing by you. 22 1 terms by which RCM would extend margin financing to RCM 2 Customers, and provides in relevant part: 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 B. MARGIN This Margin section applies in the event [RCM] finances any of your Transactions from time-totime in Financial Instruments. 1. Security Interest. [RCM] reserves the right to require the deposit or maintenance of collateral (consisting of cash, United States government obligations or such other marketable securities or other property which may be acceptable to [RCM]) to secure performance of your obligations to [RCM]. . . . To secure your obligations under Transactions entered into pursuant to this Agreement, you hereby grant to [RCM] and its affiliates (collectively, Refco Entities ) a first priority, perfected security interest in all of your cash, securities and other property (whether held individually or jointly with others) and the proceeds thereof from time-to-time in the possession or under the control of such Refco Entities, whether or not such cash, securities and other property were deposited with such Refco Entities. 2. Rights and Use of Margin. [RCM] shall have the right to loan, pledge, hypothecate or otherwise use or dispose of such cash, securities and other property free from any claim or right, until settlement in full of all Transactions entered into pursuant to this Agreement. [RCM s] sole obligation shall be to return to you such cash, like amounts of similar cash, securities and other property (or the cash value thereof in the event of any liquidation of collateral) to the extent they are not deemed to be collateral App. 154. Because RCM could not trade securities for RCM Customers accounts without oral or written instructions, it is clear that RCM Customers accounts were non-discretionary -- that is, RCM Customers, not RCM, had control over the account[s] and ha[d] full responsibility for trading decisions. de Kwiatkowski v. Bear, Stearns & Co., Inc., 306 F.3d 1293, 1302 (2d Cir. 2002). 23 1 2 3 4 5 6 7 8 9 10 to secure Transactions entered into pursuant to this Agreement with any Refco Entities or have not been applied against obligations owing by you to Refco Entities, whether as a result of the liquidation of positions and any Transactions entered into pursuant to this Agreement or otherwise. App. 154. Section B.1 states that upon RCM s extension of margin 11 financing to a customer -- even a dime -- RCM would obtain a 12 first priority, perfected security interest in all of [RCM 13 Customers ] cash, securities and other property (whether held 14 individually or jointly with others) and the proceeds thereof. 15 App. 154. 16 additional collateral in the event that a customer s collateral 17 became insufficient to secure the customer s outstanding margin 18 debt -- if, for example, the value of the customer s securities 19 collateral decreased in value such that RCM s margin loan was 20 under-secured. 21 Section B.1 also gave RCM the right to demand In addition, Section B.2 states that, if a customer s 22 securities are no longer deemed collateral to secure the 23 customer s outstanding margin debt, RCM was obligated to 24 return such securities to the customer. 25 the promised return did not contemplate either securities or 26 their value being returned to the actual possession of the RCM 27 Customers. 28 buying or selling by the customer and the price movements of 29 the collateral. It is evident that Margin accounts move up or down with both the The constant transfer of collateral back and 24 1 forth between accounts in RCM s name or a customer s name would 2 have imposed administrative costs on all parties, and no one 3 argues that such constant transfers were required by the 4 Customer Agreement. 5 have been aware that, if RCM was not asking for more 6 collateral, some of their securities were probably excess 7 collateral. 8 any RCM Customer ever noticed or complained about the lack of 9 back-and-forth transfers. Moreover, all of the RCM Customers had to However, there is no allegation or indication that 10 In context, therefore, return must mean that, with 11 respect to securities not deemed to be collateral, the customer 12 could demand their return from the fungible pool. 13 the case of a requested return, RCM had the option of 14 transferring physical securities or the cash value thereof in 15 the event of any liquidation of collateral. 16 rehypothecating all its customers securities, could have 17 satisfied a demand for return of excess securities by paying 18 their cash value in lieu of the actual securities. 19 Moreover, in Thus, RCM, after On review of the Customer Agreement, we conclude that it 20 unambiguously warned the RCM Customers that RCM intended to 21 exercise full rehypothecation rights as to the Customers 22 excess margin securities. 23 Stripped of verbiage not pertinent to this dispute and 24 substituting a crude and colloquial description for the 25 specified collateral, Sections B.1 and 2 read: 25 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 B. Margin This Margin section applies in the event [RCM] finances any of your Transactions . . . in [your account]. 1. Security Interest. [RCM] reserves the right to require . . . [appropriate stuff as] collateral . . . [T]o secure performance of your obligations to [RCM] . . . you hereby grant to [RCM] . . . a first priority, perfected security interest in all your [stuff] in the possession of . . . [Refco Entities] . . . . 2. Rights and Use of Margin. [RCM] shall have the right to . . . use or dispose of such [stuff] free from any claim or right, until settlement in full of all Transactions . . . . [RCM s] sole obligation shall be to return to you such [stuff] . . . to the extent [it is] not deemed to be collateral to secure Transactions . . . . App. 154. 25 Appellants argument that the first use of such [stuff] 26 in B.2 refers only to stuff deemed to be collateral is not 27 consistent with the language of the agreement. 28 referent for the first such [stuff] is all your [stuff] in 29 B.1. 30 modified by to the extent [it is] not deemed to be collateral, 31 a most peculiar modifier if such [stuff] means only stuff 32 deemed to be collateral. 33 The only Moreover, the second use of such [stuff] in B.2 is RCM Customers also allege that RCM rehypothecated Customer 34 assets at times that RCM Customers had no outstanding margin 35 debt in breach of the Customer Agreement. 36 Agreement provides only that the cash value of securities not 26 However, the Customer 1 deemed collateral shall be return[ed] to the customers, i.e., 2 recorded on RCM s books as money payable on demand to the 3 particular customer. 4 Agreement is that, on the occasions that some customers had no 5 outstanding margin transactions, they had only a right to demand 6 payment of the value of 100 percent of the securities that had 7 been given to RCM. 8 9 A perfectly plausible reading of the There is, therefore, no disparity between the provisions of the Customer Agreement and RCM s conduct remotely supportive of 10 a claim that the Agreement was a misrepresentation actionable 11 under Section 10(b). 12 The Trade Confirmation also supports this conclusion. 13 Section D.2 of the Customer Agreement incorporates the terms of 14 the Trade Confirmation, which include, among other things, a 15 reiteration of RCM s rights to sell, pledge, hypothecate, 16 assign, invest or use, such collateral or property deposited 17 with it. 18 19 20 c) 21 Section B.2 is inconsistent with federal and/or state law and 22 that ambiguities in the Customer Agreement should be construed 23 to comply with applicable legal rules.16 App. 712. Consistency with Federal and State Law RCM Customers also contend that our interpretation of 16 RCM Customers argue Appellants also argue that the district court s interpretation was inconsistent with custom and practice, but they do not state what the customs and practices are or how they are inconsistent with this agreement. Absent allegations as to such customs and practices and given the clarity of the 27 1 that RCM was subject to SEC Rules 15c3-1, 17 C.F.R. § 240.15c3- 2 1, and 15c3-3, 17 C.F.R. § 240.15c3-3,17 and New York state law, 3 which would have limited RCM s rehypothecation rights with 4 respect to excess margin securities. 5 arguendo the existence of ambiguities in the Customer Agreement, 6 we disagree. However, even assuming 7 The district court rejected these arguments regarding 8 federal law based on our decision in United States v. Finnerty, 9 533 F.3d 143 (2d Cir. 2008). 10 RCM II, 586 F. Supp. 2d at 191-92. Finnerty held that a defendant may be liable under Section 11 10(b) and Rule 10(b)(5) for violation of a NYSE rule only if the 12 defendant had made a representation regarding compliance with 13 the rule. 14 concluded that because plaintiffs made no allegations that RCM 15 (or any Refco affiliate or employee) made any representation 16 that RCM was subject to, or would comply with, any such 17 regulations, much less [Rules 15c3-1 and 15c3-3], RCM could not Finnerty, 533 F.3d at 149-50. The district court Customer Agreement and Trade Confirmations, we will not discuss this claim further. 17 SEC Rule 15c3-1, the so-called Net Capital Rule, generally requires brokers and dealers to maintain sufficient capital to protect their customers from the firm s potential insolvency, see 17 C.F.R. § 240.15c3-1, and Rule 15c3-3, the so-called Customer Protection Rule, requires brokers and dealers to obtain and maintain physical possession or control of all fully-paid and excess margin securities in a customer s account. See 17 C.F.R. § 240.15c33(b)(1). Under Rule 15c3-3, excess margin securities is defined as those securities in the customer s account whose market value exceeds 140 percent of the customer s outstanding margin debt. 17 C.F.R. § 240-15c3-3(a)(5). Thus, the Customer Protection Rule prohibits a broker from rehypothecating a customer s margin account securities in excess of 140 percent of the customer s outstanding margin debt. 28 1 be found liable under Section 10(b) and Rule 10b-5 for violating 2 Rules 15c3-1 and 15c3-3. 3 RCM II, 586 F. Supp. 2d at 192. Here, more than simply remaining silent as to whether it 4 was complying with U.S. law, RCM represented that it was not a 5 U.S.-regulated company. 6 subject to all applicable laws in the trade confirmations, 7 that simply raises the question of what laws were applicable. 8 In short, RCM s alleged violation of federal law does not in and 9 of itself constitute deceptive conduct. Although RCM did state that it was 10 The Security and Exchange Commission has expressed a 11 concern, as amicus curiae, that affirming the district court in 12 this regard will viscerate the so-called shingle theory of 13 broker-dealer liability under Section 10(b), and will be 14 inconsistent with our recent decision in VanCook v. SEC, 653 15 F.3d 130 (2d Cir. 2011). We disagree. 16 Under the shingle theory, a broker makes certain implied 17 representations and assumes certain duties merely by hanging 18 out its professional shingle. 19 Inc., 147 F.3d 184, 192 (2d Cir. 1998). 20 Grandon v. Merrill Lynch & Co., In VanCook, we held that VanCook s late-trading practice 21 violated [Rule 10b-5] because it constituted an implied 22 representation to mutual funds that VanCook was complying with 23 a rule restricting late-trading. 24 reasoned that by submitting orders after that time for 25 execution at the current day s [Net Asset Value], VanCook made 29 VanCook, 653 F.3d at 141. We 1 an implied representation that the orders had been received 2 before 4:00 p.m., because such late trading incorporates an 3 implicit misrepresentation by falsely making it appear that the 4 orders were received by the intermediary before 4:00 p.m. when 5 in fact they were received after that time. 6 (internal quotation marks and alterations omitted). 7 noted that VanCook s scheme violated his employer mutual funds 8 own express wish s, as set out in their propectuses, id. at 9 140, and involved steps to make it appear to any outside 10 observer . . . that his customers . . . orders had been 11 finalized by 4:00 p.m., id. 12 implied misrepresentations, we affirmed the order of the SEC 13 that VanCook violated Rule 10b-5 and Section 10(b). 14 Id. at 140-41 We also Based in part on the explicit and Id. at 141. However, the facts alleged in the instant matter do not, as 15 asserted by appellant, give rise to liability based on conduct 16 inconsistent with an implied representation; specifically a 17 broker-dealer s implied representation under the shingle 18 theory that it will deal fairly with the public in accordance 19 with the standards of the profession. 20 at 2. 21 a U.S.-regulated company trump any implied representation under 22 the shingle theory. Appellants 18(j) Letter Surely, RCM s affirmative representations that it was not 23 Indeed, we have previously denied shingle theory claims 24 against a broker that made adequate explicit disclosure with 25 regard to the subject matter of the claimed implied duties. 30 See 1 Starr ex rel. Estate of Sampson v. Georgeson S'holder, Inc., 412 2 F.3d 103, 111 (2d Cir. 2005) (denying plaintiffs' Rule 10b-5 3 claim under the shingle theory because defendant disclosed 4 allegedly excessive markups). 5 Customer Agreement and its standard form Trade Confirmation 6 expressly disclosed RCM's rehypothecation rights as well as 7 RCM's status as an offshore unregulated entity. 8 disclosures were made in conjunction with a bargained-for 9 agreement between sophisticated counter-parties that could be In the instant case, RCM's These 10 expected to understand the relevant benefits and risks. 11 Thus, there is no liability under the shingle theory. 12 The terms of the Customer Agreement indicated that, insofar 13 as RCM was acting as executing broker for its customers, RCM was 14 not purporting to comply with the Rules in question but was 15 relying on the safe harbor from broker registration provided 16 under SEC Rule 15a-6, 17 C.F.R. § 240.15a-6. 17 15a-6 exempts from the federal broker-dealer registration 18 requirements of Section 15(a) of the Exchange Act, 15 U.S.C. § 19 78o, foreign entities engaged in certain activities involving 20 U.S. investors and securities markets. 21 Requirements for Foreign Broker-Dealers, Exchange Act Release 22 No. 27,017, 54 Fed. Reg. 30013, 30013 (July 18, 1989). 23 particular, Rule 15a-6(a)(3) exempts from registration foreign 31 In general, Rule See Registration In 1 brokers18 that induce or attempt to induce trades in securities 2 by major U.S. institutional investors and U.S. institutional 3 investors so long as any trades are effected through a U.S.- 4 registered broker-dealer and various conditions are met both by 5 the foreign broker and the registered dealer that effects the 6 trades. 7 See 17 C.F.R. § 240.15a-6(a)(3)(i)(A). Section G.1 of the Customer Agreement, entitled Respective 8 Status of [RCM] and RSL, provides in relevant part: 9 10 11 12 13 14 15 [RCM] and RSL are all wholly owned subsidiaries of the Refco Group Ltd., LLC, a US corporation. RSL is a US corporation and a broker-dealer registered with the US Securities and Exchange Commission. [RCM] is a Bermuda Corporation. 16 App. 156-57. This language clearly indicates that RSL is a U.S. 17 corporation and registered with the SEC, thereby implying that 18 RSL would comply with SEC regulations. 19 represents RCM only as a Bermuda Corporation and makes no 20 suggestion that RCM was registered with the SEC or would comply 21 with federal securities regulations. 22 Agreement s frequent references to RSL as introducing 18 However, Section G.1 Furthermore, the Customer Under Rule 15a-6, a foreign broker or dealer is defined as: [A]ny non-U.S. resident person (including any U.S. person engaged in business as a broker or dealer entirely outside the United States, except as otherwise permitted by this rule) that is not an office or branch of, or a natural person associated with, a registered broker or dealer, whose securities activities, if conducted in the United States, would be described by the definition of broker or dealer in sections 3(a)(4) or 3(a)(5) of the Act. 17 C.F.R. § 240.15a-6(b)(3). 32 1 transactions to RCM on the customers behalf clearly represented 2 that trades executed at RCM for its customers would be effected 3 through RSL to RCM in accordance with the requirements of Rule 4 15a-6(a)(3)(i)(A).19 5 Accordingly, whether or not RCM was technically in 6 compliance with the Rule 15a-6(a)(3) safe harbor,20 the Customer 7 Agreement clearly represented that RCM undertook no obligation 8 to comply with Rules 15c3-1 and 15c3-3. 9 Similarly, to the extent that RCM was acting as its 10 customers prime broker, RCM undertook no apparent obligation to 11 comply with federal securities laws, including Rules 15c3-1 and 12 15c3-3. 13 role and function of RCM when acting as prime broker and states: 14 15 16 17 18 19 20 21 22 Section G.1 of the Customer Agreement establishes the Trades Executed Away From [RCM], but cleared by [RCM] (Prime Brokerage) - [RCM] acts as your clearing, settlement and financing agent (your prime broker) in connection with Transactions executed at your Executing Broker(s). Where [RCM] is acting as your prime broker, no [RCM] entity is involved in executing Transactions. App. 157. 19 Although RCM would have been exempt from registration under Rule 15a6, RSL, as introducing broker, would have been required to comply with Rules 15c3-1 and 15c3-3, because, pursuant to Rule 15a-6, the U.S.-registered broker through which transactions between the U.S. customer and the foreign broker are effected retains responsibility for, inter alia, complying with Rules 15c3-1 and 15c3-3. See 17 C.F.R. §§ 240.15a-6(3)(iii)(A)(5),(6). Thus, to the extent that trades were executed by RCM for its customers, with RSL acting as introducing broker, it was RSL, not RCM, that bore the responsibility of complying with Rules 15c3-1 and 15c3-3. 20 RCM Customers cite in their complaint a draft memorandum from Refco s counsel, Mayer, Brown, Rowe & Maw LLP, expressing counsel s view that RCM was unable to rely on the exemption from U.S. registration provided by Rule 15a-6. 33 1 The SEC has defined prime broker as a registered broker- 2 dealer that clears and finances the customer trades executed by 3 one or more other registered broker-dealers ( executing broker ) 4 at the behest of the customer. 5 No-Action Letter, 1994 WL 808441, at *1 (Jan. 25, 1994). 6 Commission requires prime brokers to comply with certain federal 7 securities laws, including Rules 15c3-1 and 15c3-3. 8 However, insofar as RCM was not a U.S.-registered broker-dealer, 9 and thus not a prime broker for purposes of complying with 10 U.S. federal securities laws, RCM, when acting in its role as 11 prime broker, was not representing that it would comply with 12 Rules 15c3-1 and 15c3-3.21 13 Customer Agreement represented that RCM intended to exercise 14 full rehypothecation rights without being subject to the Rules 15 in question. 16 Prime Broker Comm. Request, SEC The Id. at *11. We therefore conclude that the RCM Customers also assert that RCM was subject to New York 17 General Business Law Section 339-e, which, in general, restricts 18 a broker s rehypothecation rights with respect to fully-paid or 19 excess margin securities. 20 2004). 21 Section H of the Customer Agreement and Paragraph 6 of the Trade N.Y. Gen. Bus. Law § 339-e (McKinney RCM Customers argue that Section 339-e applies because 21 We cannot, from the pleadings, reach any conclusions as to whether, at the time it rehypothecated its customers securities, RCM was acting as executing broker or prime broker. Nor can we make any conclusions as to whether RCM and/or RSL were actually in compliance with Rules 15a-6, 15c3-1 or 15c3-3. Such conclusions are not, however, pertinent to our disposition of this matter. 34 1 Confirmation specified that the agreement would be governed by, 2 and construed in accordance with, New York law. 3 Section H of the Customer Agreement, entitled LAW AND 4 JURISDICTION, reads: 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 In particular, This Agreement shall be governed by and construed with New York law and you agree that the courts of New York, located in the Borough of Manhattan (Federal or State), are to have jurisdiction to settle any disputes which may arise out of or in connection with this Agreement. Any suit, action or proceedings arising out of or in connection with this Agreement ( Proceedings ) commenced by you, may only be brought in New York. [RCM] may take proceedings against you in New York (Federal or State) or any other court of competent jurisdiction, US or otherwise. The taking of Proceedings by [RCM] in one or more jurisdictions does not preclude the taking of Proceedings by [RCM] in any other jurisdiction, whether concurrently or not. You irrevocably waive (and irrevocably agree not to raise) any objection which you may have now or subsequently to [RCM s] laying of the venue of any Proceedings in any court and any claim that any such Proceedings have been brought in an inconvenient forum. App. 157. The district court determined that Section H constituted a 29 choice of law provision that governed only the Customer 30 Agreement itself. 31 RCM Customers assert that Section H establishes that New York 32 law governed the overall relationship between RCM and RCM 33 Customers, including RCM s use of RCM Customers collateral. 34 agree with the district court. 35 represented, any affirmative obligations on RCM to conform to RCM II, 586 F.Supp.2d at 192 n.27. However, We Section H neither created, nor 35 1 New York margin-lending restrictions.22 2 provision was included only as a choice of law and venue 3 provision that would govern should any conflicts arise out of 4 or in connection with the Customer Agreement. 5 6 7 d) 8 appellants also claim that the monthly account statements sent 9 by RCM were deceptive because those statements identified 10 security positions that were In Your Account and other 11 securities as Open Financing Transactions, indicating that the 12 latter were being held as collateral. 13 statements implied that the securities held In Your Account 14 were not being rehypothecated but were being held on behalf of 15 the customer. 16 By its clear terms, the The Account Statements as a Misrepresentation In addition to their deception-in-the-contract argument, They argue that these However, no such inference could reasonably have been drawn 17 by a signatory to the Customer Agreement, which gave RCM the 18 right to rehypothecate all securities, whether excess collateral 19 or not, as discussed supra. 20 Agreement, the distinction between collateral securities and Based on the terms of the Customer 22 The Trade Confirmation also did not create, deceptively or otherwise, an inference that New York law would apply. Paragraph 6 of the Trade Confirmation provides that: All transactions between RCM and you shall be subject to all applicable laws, rules, practices and customs and to the terms of the applicable customer agreement and of any other written agreement between you and RCM. App. 712. This provision cannot be portrayed as deceptive in this matter because neither the Trade Confirmation nor the Customer Agreement state which bodies of laws are applicable. 36 1 non-collateral securities had no bearing on rehypothecation 2 rights, but rather on what securities, or the equivalent cash 3 value thereof, customers could withdraw from their account. 4 Thus, these statements do not purport to make any 5 representation, deceptive or otherwise, about what securities 6 may or may not have been rehypothecated. 7 8 9 e) Oral Statements by RCM Representatives RCM Customers also allege that oral statements made by RCM 10 representatives were deceptive. 11 discussions about the RCM Customers desire for low-risk 12 investments and a safe place to hold securities, RCM 13 representatives stated that: 14 proprietary trading; (ii) their business involved only 15 executing, clearing, and financing trades in exchange for 16 commissions and interest payments; and (iii) RCM s securities 17 financing business was a matched-book, which insulated RCM from 18 direct market risk.23 19 statements created the perception that RCM was a dependable 20 custodian for their securities and would not rehypothecate 21 excess margin securities. 22 They state that during (i) RCM did not engage in Appellants argue that, in context, these However, none of these statements had any bearing on how 23 RCM intended to use excess margin securities. 24 that RCM s business was that of a broker-dealer and that it took 23 They state only In a matched-book business, a broker accepts securities as collateral for a loan and then uses those same collateral securities to borrow funds, thereby offsetting its exposure to risk that the original loan will become under-secured. 37 1 steps to limit its risk. 2 sophisticated, investor would understand these statements as an 3 affirmative representation that RCM would not rehypothecate 4 excess margin securities. 5 No reasonable, much less Moreover, any doubt was removed by the terms of the 6 Customer Agreements, which granted RCM the right to 7 rehypothecate all customer securities whenever a customer had a 8 margin balance and the right to return customer securities in 9 the form of cash. These provisions clearly represented that 10 securities might be tied up in transactions even when not deemed 11 to be collateral. 12 RCM concerning the rehypothecation of customer securities were 13 the terms of the Customer Agreement, which were not deceptive.24 14 CONCLUSION 15 16 Therefore, the only affirmative statements by We have also considered appellants remaining claims and find them without merit. For the foregoing reasons, we affirm. 17 18 24 We note two additional matters. First, RCM Customers do not argue that the alleged oral misrepresentations constitute a fraud independent of their rehypothecation claims. Second, if the oral statements might be taken to suggest that RCM would not rehypothecate excess margin securities, there is caselaw holding that the written statement controls the oral one. Ambrosino v. Rodman & Renshaw, Inc., 972 F.2d 776, 786 (7th Cir. 1992) (quoting Teamsters Local 282 Pension Trust Fund v. Angelos, 762 F.2d 522, 530 (7th Cir. 1985)). 38
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