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In re Refco

January 14, 2008


The opinion of the court was delivered by: Denise Cote, District Judge

This Document Relates to:



Appellants Paul Palley ("Palley"), David Bilodeau ("Bilodeau"), and Mark Resnick ("Resnick") (collectively, "Appellants"), proceeding pro se, appeal from an April 19, 2007, Order of the United States Bankruptcy Court for the Southern District of New York disallowing their requests for payment of administrative expense claims in connection with the Chapter 11 bankruptcy of Refco, Inc. and its affiliated companies (the "Order").*fn1 By an Order of July 12, 2007, the three appeals were consolidated. The consolidation Order accepted the "Statements of Issues" filed by the Appellants as their appeal briefs. On August 3, 2007, RJM, LLC -- the plan administrator for Refco F/X Associates, LLC ("FXA"), Refco, Inc., and certain of its affiliates and subsidiaries (collectively, the "Debtors" or "Appellees") under the Modified Joint Chapter 11 Plan of Refco, Inc. and Certain of Its Direct and Indirect Subsidiaries (the "Plan") -- submitted a consolidated responsive brief.*fn2 For the reasons stated below, the April 19, 2007, Order of the Bankruptcy Court is affirmed.


The following facts are undisputed and taken from the submissions of the parties, including the documents submitted to the Bankruptcy Court and designated by the parties as constituting the record on appeal. Prior to the bankruptcy, Refco, Inc., along with its affiliated entities, was a diversified financial services organization with operations in more than a dozen countries and a global institutional and retail client base. FXA, one of Refco, Inc.'s many affiliated and subsidiary entities, was engaged in an on-line retail foreign exchange trading business under the trade name Appellants were FXA customers who held trading accounts with the company. This appeal concerns trading activity that took place in the Appellants' accounts following the bankruptcy filing.

FXA's business was operated pursuant to the terms of a Facilities Management Agreement (the "FMA") between Refco Group Ltd., LLC ("RGL") and Forex Capital Markets, LLC ("FXCM"). Under the FMA, FXCM agreed to service certain foreign exchange accounts for designated affiliates of RGL, including FXA. FXCM serviced the accounts through an internet platform that it owned and operated. FXCM also provided, inter alia, representatives to answer client telephone calls. RGL affiliates, such as FXA, were responsible for, inter alia, due diligence, customer compliance, and maintaining relationships with introducing brokers. FXA also maintained all cash accounts associated with the business, including the customer accounts at issue here. FXA maintained the funds received from clients in various bank accounts, including foreign exchange trading accounts at its affiliate Refco Capital Markets, Ltd., a Bermuda company ("RCM"). Prior to the bankruptcy, clients deposited trading funds with FXA, and FXA issued any disbursements to clients who wished to withdraw funds.*fn3

Appellees describe the conduct of FXA's foreign exchange trading business as follows:

The Refco Affiliates [such as FXA] would serve as the counter-parties to each foreign exchange transaction made by their respective clients. Trades on the FXCM online platform did not require delivery. Consequently, client account balances represented the Refco Affiliate's liability to the client, but did not reflect currencies or investments that the Refco Affiliate actually held. For example, if a client deposited funds in U.S. dollars to its account, the Refco Affiliate would have a liability to the client in an amount equal to the deposit. If the client then bought and sold Japanese yen, and made a profit on the trade, the Refco Affiliate's U.S. dollar liability to the client would increase. Conversely, if the client lost money on its trade, the Refco Affiliate's U.S. dollar obligation to the client would decrease. Throughout the client's trading, the Refco Affiliate would not actually buy and sell Japanese yen in the open market from a third party each time its client "bought" or "sold" yen. Rather, it would, in its discretion, sometimes hedge all or part of its exposure to clients. Sometimes it would not. The Refco Affiliate generated its profit, if any, to the extent that aggregate client losses exceeded aggregate client gains, net of any hedging activity engaged in by the Refco Affiliate.

As stated in documents submitted to the Bankruptcy Court, "[u]ntil the filing of the chapter 11 cases, FXA had been a very profitable business for Refco."

Following the revelation of executive misconduct and accounting irregularities at Refco, Inc.,*fn4 the Debtors filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") on October 17, 2005 (the "Petition Date"). Pursuant to 11 U.S.C. § 541(a), an estate was then created consisting of all of FXA's property and assets, and FXA was prohibited under 11 U.S.C. § 362 from permitting clients to withdraw funds from their accounts. In addition, according to Appellees' submissions below, FXA was similarly rendered unable to access the customer funds it had deposited with RCM, also a debtor in the Chapter 11 cases. In light of these developments, Refco affiliates, including FXA, also stopped accepting deposits to client accounts on the Petition Date.*fn5

As Appellees describe in their brief, although post-Petition trading would ordinarily not have been permitted under these circumstances, two factors contributed to a decision to permit trading to resume shortly after the Petition Date. First, the internet platform operated by FXCM and through which customers conducted their trading remained operational, and thus FXA had the ability to permit post-Petition trading using the existing customer account balances. Second, shortly after the Petition Date, FXCM approached the Debtors regarding the potential acquisition of, inter alia, the retail foreign exchange accounts and related cash balances held by FXA, as well as a 35% stake in FXCM then held by RGL. As the documents submitted to the Bankruptcy Court --- and the Appellees' brief to this Court -- indicate, FXA and FXCM believed that the value of both the customer accounts and of RGL's 35% stake in FXCM would be maximized, and a successful sale more likely, if the FXA customer accounts remained active pending the acquisition.*fn6

Thus, following three weeks of negotiations, an agreement was reached on November 9, 2005, and embodied in a Memorandum of Understanding signed by representatives of Refco, Inc. and FXCM (the "MOU"). Under the terms of the MOU, trading on the FXCM-maintained internet platform would be permitted to resume pending completion of the acquisition and confirmation by the Bankruptcy Court. Appellees' state, however, that (1) FXA did not engage in any hedging activity during the post-Petition period, (2) the "actual dollars and cents in the [Appellants'] accounts were 'frozen' as a result of the bankruptcy," and (3) as a result, "post-petition trading merely changed the amount of FXA's nominal liabilities to its clients on account of their pre-petition claim amounts," and did not correspond to any "real" buying and selling on the open market. Similarly, while clients could direct trading in their accounts, they could not contribute additional funds or receive any disbursements.

As the Appellants have each highlighted, a Stipulation entered into on November 19, 2005, in connection with the MOU and so-ordered by the Bankruptcy ...

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