Opinion ID: 2482599
Heading Depth: 1
Heading Rank: 1

Heading: Kirschner

Text: This lawsuit was triggered by the collapse of Refco, once a leading provider of brokerage and clearing services in the derivatives, currency and futures markets. After a leveraged buyout in August 2004, Refco became a public company in August 2005 by way of an initial public offering. [1] In October 2005, Refco disclosed that its president and chief executive officer had orchestrated a succession of loans, apparently beginning as far back as 1998, which hid hundreds of millions of dollars of the company's uncollectible debt from the public and regulators. These maneuvers created a falsely positive picture of Refco's financial condition. [2] In short order, this revelation caused Refco's stock to plummet and RCM, Refco's brokerage arm, to experience a run on customer accounts, forcing Refco to file for bankruptcy protection. In December 2006, the United States Bankruptcy Court for the Southern District of New York confirmed Refco's chapter 11 bankruptcy plan, which became effective soon thereafter. Under the plan, secured lenders, who were owed $717 million, were paid in full; Refco's bondholders and the securities customers and unsecured creditors of RCM were due to receive 83.4 cents, 85.6 cents and 37.6 cents on the dollar, respectively; and Refco's general creditors with unsecured claims could expect from 23 cents to 37.6 cents on the dollar ( see One Chapter of Refco Saga Closed, 47 Bankr Ct Decisions Wkly News & Comment [No. 13], Jan. 16, 2007, at 2; Refco Exits Bankruptcy Protection, New York Times, Dec. 27, 2006, section C, at 3). The plan also established a Litigation Trust, which authorized plaintiff Marc S. Kirschner, as Litigation Trustee, to pursue claims and causes of action possessed by Refco prior to its bankruptcy filing. The Litigation Trust's beneficiaries are the holders of allowed general unsecured claims against Refco. Any recoveries are to be allocated, after repayment of up to $25 million drawn from certain Refco assets to administer the Trust, on the basis of the beneficiaries' allowed claims under the confirmed plan. In August 2007, the Litigation Trustee filed a complaint in Illinois state court asserting fraud, breach of fiduciary duty and malpractice against Refco's president and CEO and other owners and senior managers (collectively, the Refco insiders); investment banks that served as underwriters for the LBO and/or the IPO; Refco's law firm; accounting firms that had provided services to Refco; and several customers that participated in the allegedly deceptive loans. According to the Trustee, these defendants all aided and abetted the Refco insiders in carrying out the fraud, or were negligent in neglecting to discover it. A year later, the Litigation Trustee filed a complaint in Massachusetts state court, asserting similar claims against the accounting firm KPMG LLP. Both lawsuits were removed to federal court and transferred to the Southern District of New York for coordinated or consolidated proceedings. Defendants subsequently moved to dismiss the Litigation Trustee's claims pursuant to rule 12 (b) (1) and (6) of the Federal Rules of Civil Procedure, and the District Court granted the motions on April 14, 2009. Because the Trustee acknowledged that the Refco insiders masterminded Refco's fraud, the judge identified as the threshold issue whether the claims were subject to dismissal by virtue of the Second Circuit's Wagoner rule ( see Shearson Lehman Hutton, Inc. v Wagoner, 944 F2d 114, 118 [2d Cir 1991] [bankruptcy trustee does not possess standing to seek recovery from third parties alleged to have joined with the debtor corporation in defrauding creditors]). [3] Further, since [a]ll parties agree[d] that if the Wagoner rule applie[d], the Litigation Trustee lack[ed] standing to assert any of Refco's claims against the defendants, the judge observed that the parties' dispute focus[ed] solely on whether the narrow exception to the Wagoner rulethe `adverse-interest' exceptionapplie[d] ( Kirschner v Grant Thornton LLP, 2009 WL 1286326, , 2009 US Dist LEXIS 32581, -20 [2009]). Citing Second Circuit cases handed down after our decision in Center v Hampton Affiliates (66 NY2d 782 [1985]), the District Court noted that, in order for the adverse interest exception to apply, the [corporate officer] must have totally abandoned [the corporation's] interests and be acting entirely for his own or another's purposes ... because where an officer acts entirely in his own interests and adversely to the interests of the corporation, that misconduct cannot be imputed to the corporation (2009 WL 1286326, , 2009 US Dist LEXIS 32581,  [citations and internal quotation marks omitted]). Further, [i]n determining whether an agent's actions were indeed adverse to the corporation, courts have identified `[t]he relevant issue [as being the] short term benefit or detriment to the corporation, not any detriment to the corporation resulting from the unmasking of the fraud' (2009 WL 1286326, , 2009 US Dist LEXIS 32581, , quoting In re Wedtech Corp., 81 BR 240, 242 [SD NY 1987]). The District Court concluded that [t]his line of precedent foreclose[d] the Trustee's claims because the complaint was saturated by allegations that Refco received substantial benefits from the [Refco] insiders' alleged wrongdoing (2009 WL 1286326, , 2009 US Dist LEXIS 32581, ). Thus, under the Trustee's own allegations the Refco insiders stole for Refco, not from iti.e., the burden of the [Refco] insiders' fraud was not borne by Refco or its then-current shareholders who were themselves the [Refco] insidersbut rather by outside parties, including Refco's customers, creditors, and third parties who acquired shares through the IPO (2009 WL 1286326, , 2009 US Dist LEXIS 32581, ). In reaching his decision, the judge rejected as without merit the Litigation Trustee's industrious interpretation of the Second Circuit's decision in In re CBI Holding Co., Inc. (529 F3d 432 [2d Cir 2008]), a case where the court held that a bankruptcy court's finding that the adverse interest exception applied was not clearly erroneous. The judge declined to read a solely intent-based standard into CBI because deferring to a finder-of-fact's choice as to which evidence to credit after a trial, or acknowledging that facts related to intent could contribute to the explication of how a fraud worked and to whose benefit it accrued, does not make the participants' intent the `touchstone' of the analysis such that it precludes dismissal on the pleadings (2009 WL 1286326, , 2009 US Dist LEXIS 32581, ). To hold otherwise, he reasoned, would be to explode the adverse-interest exception, transforming it from a `narrow' exception ... into a new, and nearly impermeable rule barring imputation (2009 WL 1286326,  n 14, 2009 US Dist LEXIS 32581,  n 14). The standard could not depend exclusively on the Refco insiders' subjective motivation, the judge explained, because [w]henever insiders conduct a corporate fraud they are doing so, at least in part, to promote their own advantage (2009 WL 1286326,  n 14, 2009 US Dist LEXIS 32581,  n 14). Having declined the Litigation Trustee's invitation to read CBI to inquire solely into insiders' claimed motivations, without regard to the nature and effect of their misconduct, the District Court revisited the fraud's impact on Refco. He again emphasized that the Trustee's allegations did not establish injury to Refco, because the Refco insiders did not embezzle or steal assets from Refco, but instead sold their holdings in Refco to third parties at fraudulently inflated pricesi.e., the Refco insiders' benefit came at the expense of the new purchasers of Refco securities, not Refco itself. Critically, the Trustee must allege, not that the [Refco] insiders intended to, or to some extent did, benefit from their scheme, but that the corporation was harmed by the scheme, rather than being one of its beneficiaries (2009 WL 1286326, , 2009 US Dist LEXIS 32581, ). Plaintiff appealed to the Second Circuit Court of Appeals. After presenting a comprehensive account of the Litigation Trustee's factual allegations and the District Court's decision, the court remarked that the parties seemingly did not dispute several propositions in the lower court's decision, which appear[ed] to correctly reflect New York law concerning the adverse interest exception ( Kirschner v KPMG LLP, 590 F3d 186, 191 [2d Cir 2009]); specifically, that the adverse interest exception was a narrow one and that the guilty manager must have totally abandoned his corporation's interests for [the exception] to apply; and that whether the agent's actions were adverse to the corporation turns on the short term benefit or detriment to the corporation, not any detriment to the corporation resulting from the unmasking of the fraud ( id. [internal quotation marks omitted] [quoting the District Court's opinion]). Nonetheless, the court observed, [a]s [the District Court judge] applied these propositions to the Trustee's allegations,... he interpreted New York law in ways that [brought] the parties into sharp dispute concerning certain aspects of the adverse interest exception; namely, the state of mind of the [Refco] insiders and the harm to their corporation ( id. ). The Second Circuit noted that New York cases seem[ed] to support the District Court's conclusion that an insider's subjective intent was not the touchstone of adverse interest analysis; however, the court added, other New York cases may be read to make intent more significant ( id. at 191-192 n 3). In light of the parties' differing uses of New York cases, coupled with the somewhat divergent language used by the District Court in the pending case and by [the Second Circuit] in CBI, both endeavoring to interpret New York law, the court sought our guidance as to the scope of New York's adverse interest exception ( id. at 194). Accordingly, on December 23, 2009 the Second Circuit certified eight questions, inviting us to focus [our] attention on questions (2) and (3) ( id. at 195), which are whether the adverse interest exception is satisfied by showing that the insiders intended to benefit themselves by their misconduct; and whether the exception is available only where the insiders' misconduct has harmed the corporation, respectively ( id. at 194-195).