KENNETH M. KRYS and MARGOT MACINNIS, as Joint Official Liquidators of SPhinX Ltd., SPhinX Strategy Fund Ltd., SPhinX Plus SPC Ltd., SPhinX Distressed Ltd., SPhinX Merger Arbitrage Ltd., SPhinX Special Situations Ltd., SPhinX Macro Ltd., SPhinX Long/Short Equity Ltd., SPhinX Managed Futures Ltd., SPhinX Equity Market Neutral Ltd., SPhinX Convertible Arbitrage Ltd., SPhinX Fixed Income Arbitrage Ltd., SPhinX Distressed Fund SPC, SPhinX Merger Arbitrage Fund SPC, SPhinX Special Situations Fund SPC, SPhinX Macro Fund SPC, SPhinX Long/Short Equity Fund SPC, SPhinX Managed Futures Fund SPC, SPhinX Equity Market Neutral Fund SPC, SPhinX Convertible Arbitrage Fund SPC, SPhinX Fixed Income Arbitrage Fund SPC and PlusFunds Manager Access Fund SPC Ltd.; KENNETH M. KRYS and MARGOT MACINNIS as assignees of claims assigned by Miami Children's Hospital Foundation, OFI Palmares, Green & Smith Investment Management LLC, Thales Fund Management LLC, Kellner DiLeo & Co. LLC, Martingale Asset Management LP, Longacre Fund Management LLC, Arnhold & S. Bleichroeder Advisers LLC, Pictet & Cie, RGA America Reinsurance Company, Deutsche Bank (Suisse) SA, Arab Monetary Fund, Hansard International Ltd., Concordia Advisors LLC, Gabelli Securities, Inc. and Citco Global Custody; and THE HARBOUR TRUST CO. LTD. as Trustee of the SPhinX Trust, Plaintiffs-Appellants, -
- WILLIAM T. PIGOTT; LIBERTY CORNER CAPITAL STRATEGIES LLC; INGRAM MICRO INC.; and CIM VENTURES INC., Defendants-Appellees, CHRISTOPHER SUGRUE; MARK KAVANAGH; BRIAN OWENS; PRICEWATERHOUSECOOPERS L.L.P.; MARI FERRIS; PRICEWATERHOUSECOOPERS CAYMAN ISLANDS; GIBSON, DUNN & CRUTCHER LLP; MITCHELL KARLAN; SCOTT KISLIN; REFCO ALTERNATIVE INVESTMENTS LLC; GRANT THORNTON LLP; MARK RAMLER; ERNST & YOUNG U.S. LLP; MAYER BROWN LLP f/k/a Mayer Brown Rowe & Maw LLP; JOSEPH COLLINS; EDWARD S. BEST; PAUL KOURY; PHILLIP R. BENNETT; ROBERT C. TROSTEN; TONE GRANT; SANTO MAGGIO; THOMAS HACKL; DENNIS KLEJNA; BAWAG P.S.K. BANK FUR ARBEIT UND WIRTSCHAFT UND OSTERREICHISCHE POSTPARKASSE AKTIENGESELLSCHAFT; JP MORGAN CHASE & CO.; CREDIT SUISSE SECURITIES (USA) LLC f/k/a Credit Suisse First Boston LLC; BANC OF AMERICA SECURITIES LLC; THOMAS H. LEE PARTNERS L.P.; THOMAS H. LEE ADVISORS LLC; THL MANAGERS V LLC; THL EQUITY ADVISORS V L.P.; THOMAS H. LEE EQUITY FUND V L.P.; THOMAS H. LEE PARALLEL FUND V L.P.; THOMAS H. LEE EQUITY (CAYMAN) FUND V L.P.; THOMAS H. LEE INVESTORS LIMITED PARTNERSHIP; 1997 THOMAS H. LEE NOMINEE TRUST; THOMAS H. LEE; DAVID V. HARKINS; SCOTT L. JAECKEL; SCOTT A. SCHOEN; EMF FINANCIAL PRODUCTS LLC; EMF CORE FUND LTD.; DELTA FLYER FUND LLC; ERIC M. FLANAGAN; BECKENHAM TRADING CO. INC.; ANDREW KRIEGER; COAST ASSET MANAGEMENT LLC f/k/a Coast Asset Management LP; CS LAND MANAGEMENT LLC; CHRISTOPHER PETTIT; REFCO GROUP HOLDINGS INC.; and REFCO ASSOCIATES INC., Defendants.
Argued May 22, 2013
Remanded August 2, 2013
Reinstated September 19, 2013
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LEO R. BEUS, Phoenix, Arizona (Lee M. Andelin, Beus Gilbert, Phoenix, Arizona, David J. Molton, Andrew Dash, Brown Rudnick, New York, New York, on the brief), for Plaintiffs-Appellants.
KEVIN H. MARINO, Chatham, New Jersey (John D. Tortorella, Roseann Bassler Dal Pra, Marino, Tortorella & Boyle, Chatham, New Jersey, on the brief), for Defendants-Appellees Liberty Corner Capital Strategies LLC and William T. Pigott.
ROBERT F. WISE, JR., New York, New York (Davis Polk & Wardwell, New York, New York, on the brief), for Defendants-Appellees Ingram Micro Inc. and CIM Ventures Inc.
Before: KEARSE, POOLER, and LIVINGSTON, Circuit Judges.
KEARSE, Circuit Judge
The present appeal, brought by plaintiffs Kenneth M. Krys and Margot MacInnis as, inter alia, Joint Official Liquidators of the SPhinX Ltd. family of hedge funds (" SPhinX" or " SPhinX Funds" ), et al., challenges a partial final judgment of the United States District Court for the Southern District of New York, Jed S. Rakoff, Judge, in favor of defendants William T. Pigott, Liberty Corner Capital Strategies LLC, Ingram Micro Inc., and CIM Ventures Inc., dismissing the claims in plaintiffs' Amended Complaint. The Amended Complaint alleges that those defendants (collectively " appellees" ), in violation of New York law, aided and abetted fraud and breach of fiduciary duty by Refco Inc. and its consolidated entities (collectively " Refco" ), the brokerage and financial services firm that entered bankruptcy in 2005, and whose demise led to the bankruptcies of SPhinX and its investment manager, PlusFunds Group, Inc. (" PlusFunds" ). The district court granted appellees' motions pursuant to Fed.R.Civ.P. 12(b)(6) to dismiss the claims against them for failure to state a claim on which relief can be granted, holding that the allegations in the Amended Complaint were insufficient to plead, inter alia, the requisite knowledge by appellees of Refco's wrongdoing. On appeal, plaintiffs challenge this ruling; alternatively, they argue that they should have been allowed to file a further amended complaint to cure any pleading deficiencies. For the reasons that follow, we conclude that plaintiffs' contentions lack merit, and we therefore affirm the judgment in favor of appellees.
The present action was commenced in New York State Supreme Court in 2008 against appellees and numerous other defendants, seeking more than $263 million in compensatory and punitive damages in connection with losses suffered by plaintiffs following the bankruptcy of Refco. The action was removed to federal court by several defendants pursuant to 28 U.S.C. § § 1334(b) and 1452(a) on the ground that it was related to the pending bankruptcy cases of SPhinX, PlusFunds, and Refco. In the district court, plaintiffs filed their Amended Complaint.
A. The Amended Complaint
The Amended Complaint's factual allegations with respect to the claims asserted against appellees, which we take as true on appeal from the Rule 12(b)(6) dismissal,
see, e.g., DiFolco v. MSNBC Cable L.L.C., 622 F.3d 104, 110-11 (2d Cir. 2010), may be summarized as follows.
1. SPhinX and Refco
The SPhinX Funds, created by PlusFunds beginning in the spring of 2002, were a family of Cayman Islands-based hedge funds, offering investment portfolios that corresponded to the investment strategies represented in the S& P Hedge Fund Index. (See Amended Complaint ¶ 102.) The name " SPhinX" was " deriv[ed] . . . from the S& P Hedge Fund Index." (Id. ¶ 100 (emphases in original).) To manage the operations of SPhinX (which had no employees or physical facilities), PlusFunds, in the summer of 2002, retained a professional service provider, Derivative Portfolio Management (" DPM" ), whose co-owner and chief executive officer (" CEO" ) became a SPhinX board member. DPM was to perform all services necessary for the administration of the SPhinX Funds.
SPhinX used " segregated portfolio companies" organized under Cayman Islands
law, allowing it to protect the assets of each of its various portfolios--which represented different trading strategies--from creditors of the other SPhinX portfolios or of SPhinX's custodian and prime broker. (Amended Complaint ¶ 3.) One of SPhinX's segregated portfolio companies was SPhinX Managed Futures Fund SPC (" SMFF" ), which traded in futures and commodities.
In 2002, Refco was a leader in the financial services industry, providing execution and clearing services for exchange-traded derivatives and brokerage services in fixed income and foreign exchange markets. Prior to an initial public offering (" IPO" ) of stock by Refco Inc. in 2005, Refco Group Ltd. LLC (" RGL" ) was the parent holding company for the various Refco entities; after the IPO, Refco Inc. was the holding company and was the corporate parent of RGL. Defendant Phillip R. Bennett was the chairman, president, and CEO of RGL; he was also an owner (and after August 2004 the sole owner) of defendant Refco Group Holdings Inc. (" RGHI" ), which, until August 2004, owned 90 percent of RGL. RGHI's primary asset was its shares of RGL or, after the IPO, shares of Refco Inc. After the IPO, Bennett was chairman, president, and CEO of Refco Inc. Although RGHI was related to RGL and Refco Inc., RGHI was not considered a part of Refco, was not consolidated with it for financial reporting purposes, and is not among the entities referred to in the Amended Complaint (or in this opinion) as within the term " Refco."
Refco's three primary operating subsidiaries included Refco LLC--a Delaware company regulated by the Commodity Futures Trading Commission and the Securities Exchange Commission--and Refco Capital Markets, Ltd. (" RCM" ), a Bermuda company that was unregulated. In the fall of 2002, SMFF opened customer-segregated accounts for each of its portfolios with Refco LLC. Refco LLC became SMFF's exclusive broker worldwide, providing execution, clearing, and margin services in connection with futures and commodities trading activities.
2. The Refco Fraud and SMFF's Loss
The Amended Complaint alleges that in 1997 Refco, despite its apparent success, had begun to suffer hundreds of millions of dollars in trading losses. These, notwithstanding Refco's public representations that its business " did not involve proprietary trading" (Amended Complaint ¶ 159(q) (emphases added)), included losses from its own trading (see, e.g., id. ¶ ¶ 220, 223). They also included losses from trading by its customers to whom Refco had extended credit and from whom it did not receive reimbursement. In order to conceal the losses and fund its operations, Refco diverted customer assets, including cash from SMFF accounts, and " had no ability and no intention of returning [those] customer funds" (id. ¶ 205).
The account agreement between SPhinX and Refco required that Refco LLC maintain the assets sent by SMFF in regulated, customer-segregated accounts. Refco was well aware of the significance of that requirement, as Refco itself promoted the SPhinX Funds and created several funds that invested in SPhinX. (See id. ¶ 200; see also id. ¶ 41 (" Bennett was an investor in SPhinX" ).) Notwithstanding the account agreement, and notwithstanding the account-segregation promises in the marketing materials used by SPhinX to attract investors, DPM, at Refco's request, authorized Refco " to transfer SMFF's cash and other assets" that had been deposited with Refco LLC " interchangeably among Refco entities without regard to segregation or protection of assets" (id. ¶ 174). As a result of that authorization, " hundreds
of millions of dollars of SMFF's excess cash was [sic] transferred on a regular basis from Refco LLC, [the] regulated entity where SPhinX's assets were maintained in regulated, customer-segregated accounts, to non-customer-segregated, commingled accounts at [RCM], Refco LLC's unregulated . . . affiliate." (Id. ¶ 6.) Thus, " [m]ore than 70 percent of SMFF's cash was held at RCM," despite there being " no bona fide business reason for allowing cash to be maintained at RCM. The movement of SMFF's excess cash to RCM subjected the cash to risk of loss in the event of insolvency and resulted in the commingling of SMFF's cash in RCM's account, but offered no offsetting advantage to SPhinX." (Id. ¶ 197; see also id. ¶ ¶ 240-245.)
The Amended Complaint alleges that " [o]nce SMFF's cash was moved to RCM, Refco-related parties and conspirators" --including some SPhinX and PlusFunds officials--" used RCM's customer assets for their own benefit in fraudulent activities designed to conceal Refco losses, bolster Refco's financial statements and enrich individuals." (Amended Complaint ¶ 7; see id. ¶ ¶ 38-40, 178-179; see also id. ¶ 242 (" Refco simply took the money and property entrusted to RCM by its customers, including SPhinX and PlusFunds, and sent the funds to other Refco entities." ); id. ¶ 243 (" The diverted RCM customer assets were used by various Refco affiliates that would not have been able to sustain their operations without RCM customer funds." ).)
In October 2005, " the Refco fraud collapsed when Refco announced that it had 'discovered' a $430 million receivable owed to it by an entity controlled by Bennett ([defined as] the RGHI Receivable) and that Refco's financial statements could no longer be relied upon." (Amended Complaint ¶ 11; see id. ¶ 7.) Refco filed for bankruptcy. (See id. ¶ 11.) As a result of the wrongful transfers of SPhinX cash from Refco LLC where it had been held in segregated-portfolio and customer-segregated accounts that were protected against insolvency of other customers or of Refco, to RCM where it was commingled and unprotected, SPhinX lost approximately $263 million and suffered other damages as well.
3. Plaintiffs' Claims Against Appellees
In addition to diverting client money to its own use in order to fund its operations, Refco took steps to conceal its losses from clients and the authorities. First, instead of writing off Refco's trading losses and its uncollectible debts from customers, Bennett caused those losses and bad debts to be transferred from Refco to his own company, RGHI, in order to remove them from Refco's financial statements (see Amended Complaint ¶ ¶ 222-223), and " [a] corresponding receivable of several hundred million dollars from RGHI (the 'RGHI Receivable') was recorded on Refco's books" (id. ¶ 7). Thus, " Refco 'converted' hundreds of millions of dollars in customer and proprietary trading losses into what appeared to be a legitimate and collectible receivable from RGHI." (Id. ¶ 223.)
Second, to avoid having its audited reports and financial statements reveal that one of its supposed assets was a massive receivable from RGHI--a related entity whose principal asset was shares of Refco Inc. or its predecessor, RGL (see Amended Complaint ¶ 223)--Refco entered into allegedly " sham" loan arrangements (id. ¶ 230) with a number of its customers who were unaffiliated with Refco (see id. ¶ ¶ 231, 8), including defendants Liberty Corner Capital Strategies LLC and its owner William T. Pigott (collectively " Liberty Corner" ) and defendants Ingram Micro
Inc. and its subsidiary CIM Ventures Inc. (collectively " Ingram Micro" ), to replace the RGHI Receivable. Refco " timed" these transactions " to straddle Refco's reporting and audit periods." (Id. ¶ 230.) Characterizing the allegedly sham loan transactions by Refco with appellees (and with several other defendants (see id. ¶ 79)) as " 'round-trip loan' transactions," or " RTLs" (id. ¶ 8) and calling appellees and those defendants " RTL Participants" (id. ¶ 79), the Amended Complaint alleges that numerous multi-step RTLs occurred as follows. First,
at the end of every relevant reporting and audit period, a Refco entity (sometimes RCM) would " loan" up to $720 million to a third-party [i.e., an RTL Participant] with no apparent relation to Refco, Bennett or RGHI. That third-party entity would then " loan" the same amount to RGHI (typically via a transfer to one of RGHI's accounts at Refco). The RTL was completed when RGHI used the " loan" to pay down the debt it owed Refco. Thus, on Refco's financial statements, the RGHI Receivable was transformed into a payable on a loan owed to Refco from an unrelated third-party.
(Id. ¶ 233.) Second,
[r]ight after the start of each new reporting or audit period, the RTL was " unwound" by reversing the entire process. As the temporary pay-down of the RGHI Receivable was reversed, RGHI returned the funds it had " borrowed" from the RTL Participants, and the RTL Participants in turn paid back the money they had borrowed from Refco. ...