1 08-6166-cv L Capital Management Select Fund Ltd. v. Bennett et al. UNITED STATES COURT OF APPEALS 1 FOR THE SECOND CIRCUIT 2 August…

1
08-6166-cv(L)
Capital Management Select Fund Ltd., et al. v. Bennett et al.
UNITED STATES COURT OF APPEALS 1
FOR THE SECOND CIRCUIT 2
August Term, 2009 3
4
(Argued: October 19, 2009 Decided: January 10, 2012) 5
Docket Nos. 08-6166-cv(L) 08-6167-cv (Con) 08-6230-cv (Con) 6
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CAPITAL MANAGEMENT SELECT FUND LTD., INVESTMENT & DEVELOPMENT 8 FINANCE CORPORATION, IDC FINANCIAL S.A., GLOBAL MANAGEMENT 9 WORLDWIDE LIMITED, individually and on behalf of all others 10 similarly situated, ARBAT EQUITY ARBITRAGE FUND LIMITED, 11 RUSSIAN INVESTORS SECURITIES LIMITED, VR GLOBAL PARTNERS, L.P., 12 PATON HOLDINGS, LTD., VR CAPITAL GROUP LTD., and VR ARGENTINA 13 RECOVERY FUND LTD., 14
15 Plaintiffs-Appellants, 16
v. 17
PHILLIP R. BENNETT, PHILIP SILVERMAN, ROBERT C. TROSTEN, 18 RICHARD N. OUTRIDGE, SANTO C. MAGGIO, LEO R. BREITMAN, GRANT 19 THORNTON LLP, TONE N. GRANT, and REFCO GROUP HOLDINGS, INC., 20
21 Defendants-Appellees, 22
JOSEPH J. MURPHY, RONALD O’KELLEY, NATHAN GANTCHER, DENNIS A. 23 KLEJNA, PERRY ROTKOWITZ, CREDIT SUISSE GROUP, CREDIT SUISSE 24 FIRST BOSTON, GOLDMAN SACHS GROUP, INC., GOLDMAN SACHS & CO., 25 BANK OF AMERICA SECURITIES, LLC, BANK OF AMERICA CORP, MERRILL 26 LYNCH & CO, MERRILL LYNCH PIERCE, FENNER & SMITH INCORPORATED, 27 JP MORGAN CHASE & CO, JP MORGAN SECURITIES, INC., SANDLER 28 O’NEIL & PARTNERS, L.P., HSBC HOLDINGS, PLC, HSBC SECURITIES 29 {USA} INC., WILLIAM BLAIR & COMPANY, LLC, HARRIS NESBITT CORP., 30 CMG INSTITUTIONAL TRADING, LLC, SAMUEL A. RAMIREZ & CO., INC., 31 THE WILLIAMS CAPITAL GROUP, L.P., UTENDAHL CAPITAL PARTNERS, 32 L.P., REFCO SECURITIES, LLC, THL ENTITIES, 33
34 Defendants, 35

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*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
BANK FUR ARBEIT UND WIRTSCHAFT UND OSTERREICHISCHE POSTPARKASSE 1 AKTIENGESELLSEHAFT, GERALD M. SHERER, WILLIAM M. SEXTON, THOMAS 2 H. LEE PARTNERS, LP, THOMAS H. LEE ADVISORS, LLC, THL MANAGERS 3 V, L.L.C., THL EQUITY ADVISORS V, LLP, THOMAS H. LEE EQUITY 4 FUND V, L.P., THOMAS H. LEE PARALLEL FUND V, LP, THOMAS H. LEE 5 EQUITY (CAYMAN) FUND V, LP, THOMAS H. LEE INVESTORS LIMITED 6 PARTNERSHIP, 1997 THOMAS H. LEE NOMINEE TRUST, THOMAS H. LEE, 7 DAVID V. HARKINS, SCOTT L. JAECKEL, SCOTT A. SCHOEN, 8
9 Consolidated-Defendants. 10
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B e f o r e: WINTER and POOLER, Circuit Judges.*
12
Appeal from an order entered by the United States District 13
Court for the Southern District of New York (Gerard E. Lynch, 14
Judge), dismissing plaintiffs’ claims under Section 10(b) for 15
failure to plead deceptive conduct. We affirm. 16
SCOTT A. EDELMAN (Sander Bak & 17
Michael Shepherd, on the brief), 18 Milbank, Tweed, Hadley & McCloy 19 LLP, New York, New York, for 20 Plaintiffs-Appellants; Co-Lead 21 Counsel for Lead Plaintiffs and 22 the Putative Class. 23
24 Richard L. Stone (Mark A. 25 Strauss, on the brief), Kirby 26 McInerney & Squire LLP, New York, 27 New York, for Plaintiffs- 28 Appellants; Co-Lead Counsel for 29 Lead Plaintiffs and the Putative 30 Class. 31
32 Claire P. Gutekunst, Jessica 33 Mastrogiovanni, and Jed Friedman, 34

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3
Proskauer Rose, LLP, New York, 1 New York, for Defendant-Appellee 2 Richard N. Outridge. 3
4 Barbara Moses, Judith L. Mogul, 5 and Rachel Korenblat, Morvillo, 6 Abramowitz, Grand, Iason, Anello 7 & Bohrer, P.C., New York, New 8 York, for Defendant-Appellee 9 Robert C. Trosten. 10
11 Stuart I. Friedman, Ivan Kline, 12 and Jonathan Daugherty, Friedman 13 & Wittenstein P.C., New York, New 14 York, for Defendant-Appellee 15 William M. Sexton. 16
17 LINDA T. COBERLY and Bruce R. 18 Braun, Winston & Strawn LLP, 19 Chicago, Illinois, for Defendant- 20 Appellee Grant Thornton LLP. 21
22 Laura E. Neish, Zuckerman Spaeder 23 LLP, New York, New York, for 24 Defendant-Appellee Tone N. Grant. 25
26 David V. Kirby, Krantz & Berman, 27 LLP, New York, New York, for 28 Defendant-Appellee Philip 29 Silverman. 30
31 Susan S. McDonald, Jacob H. 32 Stillman, Mark D. Cahn, and David 33 M. Becker, Securities and 34 Exchange Commission, Washington, 35 D.C., for Amicus Curiae Securites 36 and Exchange Commission. 37
38 RICHARD A. ROSEN (Walter Rieman, 39 Paul, Weiss, Rifkind, Wharton & 40 Garrison LLP, New York, New York; 41 Greg A. Danilow, on the brief, 42 Weil Gotshal & Manges LLP, New 43 York, New York, Paul, Weiss, 44 Rifkind, Wharton & Garrison LLP, 45 New York, New York, for 46 Defendants THL Partners. 47
48

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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
WINTER, Circuit Judge: 1
Former customers (“RCM Customers”) of Refco Capital 2
Markets, Ltd. (“RCM”), a subsidiary of the now-bankrupt Refco, 3
Inc., appeal from Judge Lynch’s dismissal of their Section 4
10(b) securities fraud claims against former corporate officers 5
of Refco and Refco’s former auditor, Grant Thornton LLP. 1
6
Appellants claim that appellees breached the agreements with 7
the RCM Customers when they rehypothecated or otherwise used 8
securities and other property held in customer brokerage 9
accounts. 10
The district court dismissed the claims for lack of 11
standing and failure to allege deceptive conduct, see In re 12
Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., No. 13
06 Civ. 643, 2007 WL 2694469 (S.D.N.Y. Sept. 13, 2007) (“RCM 14
I”); In re Refco Capital Mkts., Ltd. Brokerage Customer Sec. 15
Litig., 586 F. Supp. 2d 172 (S.D.N.Y. 2008) (“RCM II”); In re 16
Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., Nos. 17
06 Civ. 643, 07 Civ. 8686, 07 Civ. 8688, 2008 WL 4962985 18
(S.D.N.Y. Nov. 20, 2008) (“RCM III”) (on a motion for 19
reconsideration). 20
We hold that appellants have no remedy under the 21
securities laws because, even assuming they have standing, they 22
fail to make sufficient allegations that their agreements with 23

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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
RCM misled them or that RCM did not intend to comply with those 1
agreements at the time of contracting. We therefore affirm. 2
BACKGROUND 3
On an appeal from a grant of a motion to dismiss, we 4
review de novo the decision of the district court. See Staehr 5
v. Hartford Fin. Servs. Group, 547 F.3d 406, 424 (2d Cir. 6
2008). We construe the complaint liberally, accepting all 7
factual allegations in the complaint as true, and drawing all 8
reasonable inferences in the plaintiff’s favor. Chambers v. 9
Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002). “To 10
survive a motion to dismiss, however, a complaint must allege a 11
plausible set of facts sufficient to raise a right to relief 12
above the speculative level.” S.E.C. v. Gabelli, 653 F.3d 49, 13
57 (2d Cir. 2011). 14
a) The Parties and Their Businesses 15
Capital Management Select Fund Limited and other named 16
appellants 2 are investment companies, which, along with members 17

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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
of the putative class, held assets in securities brokerage 1
accounts with RCM. RCM is one of three principal operating 2
subsidiaries of the now-bankrupt Refco, a publicly traded 3
holding company that, through its operating subsidiaries, 4
provided trading, prime brokerage, and other exchange services 5
to traders and investors in the fixed income and foreign 6
exchange markets. Appellees are various former officers and 7
directors of Refco and/or its affiliates (the “Refco Officer 8
Defendants”), and Refco’s former auditor, Grant Thornton, LLP. 9
RCM operated as a securities and foreign exchange broker 10
that traded in over-the-counter derivatives and other financial 11
products on behalf of its clients. Although RCM was organized 12
under the laws of Bermuda and represented itself as a Bermuda 13
corporation, it operated from New York at all relevant times. 14
These operations were under the leadership of, and through a 15
sales force of account officers and brokers employed by, its 16
affiliated corporation, Refco Securities, LLC, (“RSL”), a 17
wholly-owned subsidiary of Refco that operated as a U.S.-based 18
broker-dealer registered with the SEC. 19
b) Brokerage Account Customer Agreements 20
RCM Customers held securities and other assets in non- 21
discretionary securities brokerage accounts with RCM pursuant 22

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7
to a standard form “Securities Account Customer Agreement” with 1
RCM and RSL (the “Customer Agreement”). RCM Customers’ 2
securities and other property deposited in their accounts were 3
not segregated but were commingled in a fungible pool. As a 4
result, no particular security or securities could be 5
identified as being held for any particular customer. Such a 6
practice is common in the brokerage industry. See Levitin v. 7
PaineWebber, Inc., 159 F.3d 698, 701 (2d Cir. 1998) (“Customer 8
accounts with brokers are generally not segregated, e.g. in 9
trust accounts. Rather, they are part of the general cash 10
reserves of the broker.”); U.C.C. § 8-503 cmt. 1 (“[S]ecurities 11
intermediaries generally do not segregate securities in such 12
fashion that one could identify particular securities as the 13
ones held for customers.”); Adoption of Rule 15c3-2 Under the 14
Securities Exchange Act of 1934, Exchange Act Release No. 34- 15
7325, 1964 WL 68010, *1 (1964) (“[W]hen [customers of broker- 16
dealers] leave free credit balances with a broker-dealer the 17
funds generally are not segregated and held for the customer, 18
but are commingled with other assets of the broker-dealer and 19
used in the operation of the business.”). 20
The Customer Agreement included a margin provision that 21
permitted RCM Customers to finance their investment 22
transactions by posting securities and other acceptable 23
property held in their accounts as collateral for margin loans 24
extended by RCM. Under the margin provision, RCM, upon 25

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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
extending a margin loan to a customer, had the right to use or 1
“rehypothecate” 3 the customer’s account securities and other 2
property for RCM’s own financing purposes. For example, RCM 3
might pledge customers’ securities as collateral for its own 4
bank loans or sell the securities pursuant to repurchase 5
agreements (“repos”). 4 The parties dispute whether the 6
rehypothecation rights were limited to securities serving as 7
collateral or whether they also included securities that were 8
excess collateral. We discuss this dispute, infra. 9
We briefly provide a generic background. From an ex ante 10
perspective, such margin provisions provide distinct, but 11
related, economic benefits to both the brokerage and its 12
customers. For the customers, the margin provision provides 13
the ability to invest on a leveraged basis and thereby earn 14
amplified returns on their investment capital. As for the 15
brokerage, the ability to rehypothecate its customers’ 16
securities presents, among other things, an additional and 17
inexpensive source of secured financing. See Michelle Price, 18

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9
Picking over the Lehman Carcass - Asset Recovery, Banker, Dec. 1
1, 2008, available at 2008 WLNR 24064913 (“[Without 2
rehypothecation rights] the prime broker would have to use its 3
unsecured credit facilities, the cost of which is currently in 4
the region of 225 to 300 basis points above that of secured 5
credit.”). 6
While these types of margin provisions provide economic 7
benefits to both parties, like any creditor-debtor arrangement 8
they also create counterparty risks. The brokerage bears the 9
risk that its customers default on margin loans that could 10
become under-secured due, for example, to a precipitous decline 11
in the value of the posted collateral. Likewise, of course, 12
the customers face the possibility that the brokerage, having 13
rehypothecated its customers’ securities, fails, making it 14
unable to return customer securities after those customers meet 15
their margin debt obligations. 16
Counterparty risks associated with margin financing have 17
long been recognized by industry participants and regulators 18
alike. In the United States, for example, margin financing has 19

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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
been subject to federal 5 and state 6 regulation, and, even 1
longer still, to self-imposed limitations by brokers and self- 2
regulating organizations. 7 In general, margin restrictions 3
attempt to reduce the counterparty risk associated with margin 4
financing by limiting the types of securities that can be 5
posted by an investor as collateral for a margin loan and 6
limiting the amounts that can be borrowed against that 7
collateral. 8
8
Similarly, at least in the United States, brokers’ 9
rehypothecation activities have long been restricted by 10
federal 9 and state law, 10 and by rules promulgated by the 11

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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
principal stock exchanges. 11 These restrictions generally 1
limit a broker’s ability to commingle its customers’ securities 2
without their consent, and limit a broker’s rehypothecation 3
rights with respect to a customer’s “excess margin securities” 4
i.e., securities not deemed collateral to secure a customer’s 5
outstanding margin debt, and “fully-paid securities, ” i.e., 6
securities in a cash account for which full payment has been 7
made. 12
8
The upshot of these restrictions is that in the United 9
States, brokers and investors alike are limited in the amount 10
of leverage that is available to amplify returns. However, 11
since the development of globalized capital and credit markets, 12
investors have sought to avoid these limitations by seeking 13
unrestricted margin financing through, among other sources, 14
unregulated offshore entities. See, e.g., Metro-Goldwyn-Mayer, 15
Inc. v. Transamerica Corp., 303 F. Supp. 1354 (S.D.N.Y. 1969) 16

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12
(leveraged buyout of Metro-Goldwyn-Mayer financed through the 1
Eurodollar market, thus avoiding U.S. margin restrictions); 2
Martin Lipton, Some Recent Innovations to Avoid the Margin 3
Regulations, 46 N.Y.U. L. Rev. 1 (1971). In recent years, 4
U.S.-based broker-dealers have satisfied investor demand for 5
unrestricted margin financing by providing financing to 6
institutional investors, -- e.g., hedge funds -- through, inter 7
alia, unregulated foreign affiliates that are not subject to 8
U.S. margin or rehypothecation restrictions. See Noah Melnick 9
et al., Prime Broker Insolvency Risk, Hedge Fund J., Nov. 2008 10
(“US prime brokers commonly rely on [foreign] unregulated 11
affiliates for margin lending or securities lending and/or to 12
act as custodians in non-US jurisdictions.”); Sherri Venokur & 13
Richard Bernstein, Protecting Collateral against Bank 14
Insolvency Risk--Part I, Sept. 8, 2008, at 1 (“U.S. registered 15
broker-dealers enter into derivatives transactions through 16
their unregulated affiliates in order to reduce capital reserve 17
requirements but also to be able to use counterparty 18
collateral.”); Roel C. Campos, SEC Comm’r, Remarks before the 19
SIA Hedge Funds & Alternative Investments Conference (June 14, 20
2006) (noting that certain hedge fund financing is generally 21
booked through foreign, unregulated affiliates). 22
In the instant case, RCM held itself out as, and the 23
record indicates that at least some of the RCM Customers 24
understood it to be, an unregulated offshore broker. 25

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13
c) The Lawsuit 1
The event giving rise to this action is the collapse of 2
Refco, RCM’s now-bankrupt parent corporation. On October 20, 3
2005, a little more than two months after issuing an initial 4
public offering of its stock, Refco announced a previously 5
undisclosed $430 million uncollectible receivable and disavowed 6
its financial statements for the previous three years. The 7
uncollectible receivable stemmed, in part, from losses suffered 8
by Refco and several of its account holders during the late 9
1990s. Rather than disclose its losses to the public and its 10
investors at that time, Refco’s management devised and 11
implemented a “round robin” loan scheme to conceal the losses. 12
The first part of this scheme involved Refco transferring its 13
uncollectible receivables to the books of Refco Group Holdings, 14
Inc. (“RGHI”), an entity owned and controlled by appellee- 15
defendant Phillip R. Bennett, Refco’s then-President, CEO, and 16
Chairman. Then, in order to mask the magnitude and related- 17
party nature of the RGHI receivable, a Refco entity (alleged by 18
plaintiffs typically to be RCM) would extend loans to multiple 19
unrelated third parties that would in turn lend the funds to 20
RGHI to pay down the uncollectible receivables. In this 21
manner, Refco effectively eliminated the uncollectible related- 22
party receivable from its books just prior to each relevant 23
financial period but would unwind the loans shortly thereafter. 24
The transactions allegedly took place over the course of six 25

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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
years, between 1998 and 2004, and were never disclosed in 1
Refco’s public securities filings. By 2004, the RGHI 2
receivable had grown to an amount alleged to be in excess of $1 3
billion. 4
Prior to Refco’s 2005 disclosure, beginning in late 2003, 5
THL, a private equity investment fund that focuses on the 6
acquisition of equity stakes in mid-to-large capitalization 7
companies, began exploring investment opportunities in Refco, 8
and ultimately completed a leveraged buyout in August 2004. 9
Following Refco’s disclosure of its $430 million 10
uncollectible receivable, customers holding accounts with RCM, 11
including appellants, attempted to withdraw their assets from 12
RCM. This began the proverbial “run on the bank,” and, on 13
October 13, 2005, Refco announced a unilateral 15-day 14
moratorium on all RCM trading activities. On October 17, 2005, 15
Refco, along with RCM and several other Refco affiliates, filed 16
for Chapter 11 bankruptcy protection in the Southern District 17
of New York. In a December 30, 2005 bankruptcy filing, RCM 18
disclosed that it owed its customers approximately $4.16 19
billion, while holding only $1.905 billion in assets. 20
Along with a host of other plaintiffs who brought actions 21
in the wake of Refco’s collapse, 13 on January 26, 2006, 22

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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
plaintiff-appellant Global Management Worldwide Limited, an 1
investment fund organized under the laws of Bermuda, filed a 2
putative class action on behalf of all brokerage customers of 3
RCM who held securities with RCM and/or RSL between October 17, 4
2000 and October 17, 2005. On September 5, 2006, Global 5
Management Worldwide filed a Consolidated Amended Class Action 6
Complaint, in which Arbat Equity Arbitrage Fund Limited and 7
Russian Investors Securities Limited, both “commonly controlled 8
investment funds,” were added as Co-Lead Plaintiffs of the 9
putative class. The amended complaint named appellees as 10
defendants. The complaint alleges that Refco’s corporate 11
officers caused RCM to improperly sell or lend securities and 12
other assets from RCM Customers’ trading accounts to various 13
Refco affiliates in order to fund Refco’s operations. The 14
complaint further alleges that this practice was approved by, 15
and well known to, all members of Refco senior management. 16
On September 13, 2007, the district court dismissed the 17
putative class action suit for plaintiffs’ failure to allege 18
deceptive conduct. However, it granted plaintiffs leave to 19
replead as to certain defendants. RCM I, 2007 WL 2694469, at 20
*12-13. On October 9, 2007, two separate groups of plaintiffs 21
-- one group associated with investment fund VR Global 22
Partners, L.P., (“VR Plaintiffs”), and a second group 23

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16
associated with investment fund Capital Management Select Fund 1
Ltd. (“CM Plaintiffs”) -– filed individual actions based on 2
allegations similar to those raised in the putative class 3
action complaint. Thereafter, on November 20, 2007, the 4
district court consolidated all three actions for pretrial 5
purposes, subsequent to which the lead plaintiffs in the 6
putative class action filed a Second Amended Complaint. 7
In the consolidated action, all plaintiffs alleged 8
violations of Sections 10(b) and 20(a) of the Exchange Act and 9
Rule 10b-5 against all Refco Officer Defendants, and violations 10
of Rule 10b-16 against all Refco Officer Defendants who, 11
together with RCM and Refco, allegedly extended margin credit 12
to RCM Customers without adequately disclosing RCM’s use of 13
Customer securities. 15 U.S.C. §§ 78j(b), 78l (Sections 10(b) 14
and 20(a) of the Exchange Act); 17 C.F.R. §§ 240.10b-5, .10b-16 15
(Rules 10b-5 and 10b-16). In addition, VR Plaintiffs alleged 16
violations of Section 10(b) and Rule 10b-5 as against Grant 17
Thornton. 18
On August 28, 2008, the district court granted motions to 19
dismiss filed by various Officer Defendants and Grant Thornton. 20
RCM II, 586 F. Supp. 2d at 174. In granting the motions to 21
dismiss, the court rejected RCM Customers’ Section 10(b) claim 22
for lack of standing under the purchaser-seller rule of Blue 23
Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). RCM II, 24
586 F. Supp. 2d at 178-81. As a separate ground for dismissal, 25

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17
the court ruled that plaintiffs failed to adequately plead 1
deceptive conduct through any affirmative act or 2
misrepresentation, breach of fiduciary duty, or any other 3
manner. Id. at 181-94. 4
Finally, as to RCM Customers’ Section 20(a) claims, the 5
court concluded that because plaintiffs could not bring a claim 6
against any defendant for a primary violation of Section 10(b) 7
and Rules 10b-5 and 10b-16, plaintiffs necessarily lacked 8
standing to bring a controlling person action under Section 9
20(a). Id. at 195. 10
In considering RCM Customers’ request for leave to 11
replead, the court first noted that all plaintiffs had the 12
benefit of filing their complaints after the court’s September 13
13, 2007 Opinion and Order, which detailed the deficiencies in 14
the initial class-action pleading. Id. at 196. The court also 15
observed that VR Plaintiffs and CM Plaintiffs all had more than 16
adequate access to Refco’s internal files, including books, 17
records, and corporate minutes, as a result of their 18
participation in the Refco bankruptcy proceeding. Id. Finding 19
no indication that RCM Customers could provide additional facts 20
to cure their pleading defects, the district court denied RCM 21
Customers’ request for leave to replead. Id. 22
On September 12, 2008, plaintiffs filed a motion to 23
reconsider the district court’s denial of leave to replead. In 24
their motion, RCM Customers asserted that, given the 25

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18
opportunity to replead, they would be able to establish 1
deceptive conduct by showing that RCM improperly rehypothecated 2
the Customers’ fully-paid securities. The district court 3
granted the motion for reconsideration but again denied RCM 4
Customers leave to replead. RCM III, 2008 WL 4962985. The 5
court determined that even if RCM Customers could establish 6
deceptive conduct based on RCM’s rehypothecation of fully-paid 7
securities, plaintiffs still had no standing as “actual 8
purchaser[s] or seller[s]” under Blue Chip Stamps. Id. at *3. 9
This appeal followed. 10
DISCUSSION 11
RCM Customers seek to recover under Section 10(b) of the 12
Exchange Act, 15 U.S.C. § 78j(b). RCM Customers assert that 13
they were deceived by, inter alia, the terms of the Customer 14
Agreement and RCM’s written Trade Confirmations, RCM’s written 15
account statements, and oral representations by certain 16
appellees. 17
a) Section 10(b) 18
We turn first to Section 10(b), which makes it unlawful to 19
“use or employ, in connection with the purchase or sale of any 20
security . . . any manipulative or deceptive device or 21
contrivance in contravention of such rules and regulations as 22
the Commission may prescribe.” 15 U.S.C. § 78j(b). The 23
elements of a Section 10(b) claim are familiar to all federal 24
courts. A plaintiff claiming fraud must allege scienter, “a 25

-- 18 of 38 --

19
mental state embracing intent to deceive, manipulate, or 1
defraud,” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 2
U.S. 308, 319 (2007) (quoting Ernst & Ernst v. Hochfelder, 425 3
U.S. 185, 193 n.12 (1976)), and must “state with particularity 4
facts giving rise to a strong inference that the defendant 5
acted with the required state of mind.” 15 U.S.C. § 78u- 6
4(b)(2). A “strong inference of scienter” is one that is “more 7
than merely ‘reasonable’ or ‘permissible’ -- it must be cogent 8
and compelling, thus strong in light of other explanations.” 9
Tellabs, 551 U.S. at 323-24. This strong inference of scienter 10
can be established by alleging either “(1) that defendants had 11
the motive and opportunity to commit fraud, or (2) strong 12
circumstantial evidence of conscious misbehavior or 13
recklessness.” ECA & Local 134 IBEW Joint Pension Trust of 14
Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009). 15
Although no claim for breach of contract is pursued by 16
appellants, the gravamen of their Section 10(b) claim is such a 17
breach. Breaches of contract generally fall outside the scope 18
of the securities laws. See Gurary v. Winehouse, 235 F.3d 792, 19
801 (2d Cir. 2000) (“[T]he failure to carry out a promise made 20
in connection with a securities transaction is normally a 21
breach of contract and does not justify a Rule 10b-5 action 22
. . . unless, when the promise was made, the defendant secretly 23
intended not to perform or knew that he could not perform.” 24
(citation and internal quotation marks omitted) (quoting Mills 25

-- 19 of 38 --

20
v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 2000))); 1
Desert Land, LLC v. Owens Fin. Grp., Inc., 154 Fed. App’x. 586, 2
587 (9th Cir. 2005) (“[T]he mere allegation that a contractual 3
breach involved a security does not confer standing to assert a 4
10b-5 action.”). 5
However, although “[c]ontractual breach, in and of itself, 6
does not bespeak fraud,” Mills, 12 F.3d at 1176, it may 7
constitute fraud where the breaching party never intended to 8
perform its material obligations under the contract. See Cohen 9
v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994) (“The failure to 10
fulfill a promise to perform future acts is not ground for a 11
fraud action unless there existed an intent not to perform at 12
the time the promise was made.”). Private actions may succeed 13
under Section 10(b) if there are particularized allegations 14
that the contract itself was a misrepresentation, i.e., the 15
plaintiff’s loss was caused by reliance upon the defendant’s 16
specific promise to perform particular acts while never 17
intending to perform those acts. See Wharf (Holdings) Ltd. v. 18
United Int’l Holdings, Inc., 532 U.S. 588 (2001) (defendant 19
violated Section 10(b) when it sold a security while never 20
intending to honor its agreement); Ouaknine v. MacFarlane, 897 21
F.2d 75, 81 (2d Cir. 1990) (Section 10(b) plaintiff adequately 22
alleged facts to imply the defendants intended to deceive when 23
they issued an offering memorandum); Luce v. Edelstein, 802 24
F.2d 49, 55-56 (2d Cir. 1986) (allowing Section 10(b) claim 25

-- 20 of 38 --

21
where plaintiff alleged defendant’s promises made in 1
consideration for a sale of securities were known by defendant 2
to be false); cf. Mills, 12 F.3d at 1176 (denying Section 10(b) 3
claim because plaintiff alleged no facts probative of 4
defendant’s intent at contract formation). 5
We have also held that where a breach of contract is the 6
basis for a Section 10(b) claim, the “promise . . . must 7
encompass particular actions and be more than a generalized 8
promise to act as a faithful fiduciary.” Luce, 802 F.2d 55. 9
With respect to the present action, we add that a simple 10
disagreement over the meaning of an ambiguous contract combined 11
with a conclusory allegation of intent to breach at the time of 12
execution will not do. Either the alleged breach must be of a 13
character that alone provides “strong circumstantial evidence” 14
of an intent to deceive at the time of contract formation, ECA, 15
553 F.3d at 198, or there must be allegations of particularized 16
facts supporting a “cogent and compelling” inference of that 17
intent, Tellabs, 551 U.S. at 324; Int’l Fund Mgmt. S.A. v. 18
Citigroup Inc., Nos. 09 Civ. 8755, 10 Civ. 7202, 10 Civ. 9325, 19
11 Civ. 314, 2011 WL 4529640, at *9 (S.D.N.Y. Sept. 30, 2011). 20
In the present case, there are no particularized allegations of 21
fact supporting such an inference of deceptive intent at the 22
time of execution of the Customer Agreements. Therefore, the 23
requisite intent must be inferred, if at all, from the Customer 24
Agreement itself and the nature of the alleged breach. 25

-- 21 of 38 --

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
b) The Customer Agreement as a Misrepresentation 1
2 RCM Customers claim that they were deceived into believing 3
that their securities and other assets would be safeguarded, 4
and, in particular, that RCM would not rehypothecate excess 5
margin or fully-paid securities. They allege that, in fact, 6
RCM routinely rehypothecated all of its customers’ securities, 7
regardless of the customers’ outstanding margin debt, and did 8
so from the start of each customer’s account. The allegations 9
as to RCM’s conduct are sufficient to satisfy the element of 10
intent at the time of contract formation. The crux of the 11
issue, therefore, is whether RCM’s rehypothecation of 12
securities even when they were not deemed collateral was so 13
inconsistent with the provisions of the Customer Agreement that 14
the Agreement was itself a deception. 14
15
Section B 15 of the Customer Agreement establishes the 16

-- 22 of 38 --

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
terms by which RCM would extend margin financing to RCM 1
Customers, and provides in relevant part: 2
3 B. MARGIN 4
5
This Margin section applies in the event [RCM] 6 finances any of your Transactions from time-to- 7 time in Financial Instruments. 8
9
1. Security Interest. [RCM] reserves the right 10
to require the deposit or maintenance of 11 collateral (consisting of cash, United States 12 government obligations or such other marketable 13 securities or other property which may be 14 acceptable to [RCM]) to secure performance of 15 your obligations to [RCM]. . . . To secure your 16 obligations under Transactions entered into 17 pursuant to this Agreement, you hereby grant to 18 [RCM] and its affiliates (collectively, “Refco 19 Entities”) a first priority, perfected security 20 interest in all of your cash, securities and 21 other property (whether held individually or 22 jointly with others) and the proceeds thereof 23 from time-to-time in the possession or under the 24 control of such Refco Entities, whether or not 25 such cash, securities and other property were 26 deposited with such Refco Entities. 27
28
2. Rights and Use of Margin. [RCM] shall have 29
the right to loan, pledge, hypothecate or 30 otherwise use or dispose of such cash, securities 31 and other property free from any claim or right, 32 until settlement in full of all Transactions 33 entered into pursuant to this Agreement. [RCM’s] 34 sole obligation shall be to return to you such 35 cash, like amounts of similar cash, securities 36 and other property (or the cash value thereof in 37 the event of any liquidation of collateral) to 38 the extent they are not deemed to be collateral 39

-- 23 of 38 --

24
to secure Transactions entered into pursuant to 1 this Agreement with any Refco Entities or have 2 not been applied against obligations owing by you 3 to Refco Entities, whether as a result of the 4 liquidation of positions and any Transactions 5 entered into pursuant to this Agreement or 6 otherwise. 7
8
App. 154. 9
Section B.1 states that upon RCM’s extension of margin 10
financing to a customer -- even a dime -- RCM would obtain a 11
“first priority, perfected security interest in all of [RCM 12
Customers’] cash, securities and other property (whether held 13
individually or jointly with others) and the proceeds thereof.” 14
App. 154. Section B.1 also gave RCM the right to demand 15
additional collateral in the event that a customer’s collateral 16
became insufficient to secure the customer’s outstanding margin 17
debt -- if, for example, the value of the customer’s securities 18
collateral decreased in value such that RCM’s margin loan was 19
under-secured. 20
In addition, Section B.2 states that, if a customer’s 21
securities are no longer deemed collateral to secure the 22
customer’s outstanding margin debt, RCM was obligated to 23
“return” such securities to the customer. It is evident that 24
the promised “return” did not contemplate either securities or 25
their value being returned to the actual possession of the RCM 26
Customers. Margin accounts move up or down with both the 27
buying or selling by the customer and the price movements of 28
the collateral. The constant transfer of collateral back and 29

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25
forth between accounts in RCM’s name or a customer’s name would 1
have imposed administrative costs on all parties, and no one 2
argues that such constant transfers were required by the 3
Customer Agreement. Moreover, all of the RCM Customers had to 4
have been aware that, if RCM was not asking for more 5
collateral, some of their securities were probably excess 6
collateral. However, there is no allegation or indication that 7
any RCM Customer ever noticed or complained about the lack of 8
back-and-forth transfers. 9
In context, therefore, “return” must mean that, with 10
respect to securities not deemed to be collateral, the customer 11
could demand their return from the fungible pool. Moreover, in 12
the case of a requested “return,” RCM had the option of 13
transferring physical securities or the “cash value thereof in 14
the event of any liquidation of collateral.” Thus, RCM, after 15
rehypothecating all its customers’ securities, could have 16
satisfied a demand for “return” of excess securities by paying 17
their cash value in lieu of the actual securities. 18
On review of the Customer Agreement, we conclude that it 19
unambiguously warned the RCM Customers that RCM intended to 20
exercise full rehypothecation rights as to the Customers’ 21
excess margin securities. 22
Stripped of verbiage not pertinent to this dispute and 23
substituting a crude and colloquial description for the 24
specified collateral, Sections B.1 and 2 read: 25

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26
B. Margin 1
2 This Margin section applies in the event 3 [RCM] finances any of your Transactions . . . in 4 [your account]. 5
6 1. Security Interest. [RCM] reserves the 7
right to require . . . [appropriate stuff as] 8 collateral . . . [T]o secure performance of your 9 obligations to [RCM] . . . you hereby grant to 10 [RCM] . . . a first priority, perfected security 11 interest in all your [stuff] in the possession of 12 . . . [Refco Entities] . . . . 13
14 2. Rights and Use of Margin. [RCM] shall 15
have the right to . . . use or dispose of such 16 [stuff] free from any claim or right, until 17 settlement in full of all Transactions . . . . 18 [RCM’s] sole obligation shall be to return to you 19 such [stuff] . . . to the extent [it is] not 20 deemed to be collateral to secure Transactions 21 . . . . 22
23 App. 154. 24
Appellants’ argument that the first use of “such [stuff]” 25
in B.2 refers only to “stuff” deemed to be collateral is not 26
consistent with the language of the agreement. The only 27
referent for the first “such [stuff]” is “all your [stuff]” in 28
B.1. Moreover, the second use of “such [stuff]” in B.2 is 29
modified by “to the extent [it is] not deemed to be collateral,” 30
a most peculiar modifier if “such [stuff]” means only “stuff” 31
deemed to be collateral. 32
RCM Customers also allege that RCM rehypothecated Customer 33
assets at times that RCM Customers had no outstanding margin 34
debt in breach of the Customer Agreement. However, the Customer 35
Agreement provides only that the cash value of securities not 36

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16 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
deemed collateral shall be “return[ed]” to the customers, i.e., 1
recorded on RCM’s books as money payable on demand to the 2
particular customer. A perfectly plausible reading of the 3
Agreement is that, on the occasions that some customers had no 4
outstanding margin transactions, they had only a right to demand 5
payment of the value of 100 percent of the securities that had 6
been given to RCM. 7
There is, therefore, no disparity between the provisions of 8
the Customer Agreement and RCM’s conduct remotely supportive of 9
a claim that the Agreement was a misrepresentation actionable 10
under Section 10(b). 11
The Trade Confirmation also supports this conclusion. 12
Section D.2 of the Customer Agreement incorporates the terms of 13
the Trade Confirmation, which include, among other things, a 14
reiteration of RCM’s rights to “sell, pledge, hypothecate, 15
assign, invest or use, such collateral or property deposited 16
with it.” App. 712. 17
c) Consistency with Federal and State Law 18
19 RCM Customers also contend that our interpretation of 20
Section B.2 is inconsistent with federal and/or state law and 21
that ambiguities in the Customer Agreement should be construed 22
to comply with applicable legal rules. 16 RCM Customers argue 23

-- 27 of 38 --

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. § 240.15c3-
3(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
that RCM was subject to SEC Rules 15c3-1, 17 C.F.R. § 240.15c3- 1
1, and 15c3-3, 17 C.F.R. § 240.15c3-3, 17 and New York state law, 2
which would have limited RCM’s rehypothecation rights with 3
respect to excess margin securities. However, even assuming 4
arguendo the existence of ambiguities in the Customer Agreement, 5
we disagree. 6
The district court rejected these arguments regarding 7
federal law based on our decision in United States v. Finnerty, 8
533 F.3d 143 (2d Cir. 2008). RCM II, 586 F. Supp. 2d at 191-92. 9
Finnerty held that a defendant may be liable under Section 10
10(b) and Rule 10(b)(5) for violation of a NYSE rule only if the 11
defendant had made a representation regarding compliance with 12
the rule. Finnerty, 533 F.3d at 149-50. The district court 13
concluded that because plaintiffs made no allegations that “RCM 14
(or any Refco affiliate or employee) made any representation 15
that RCM was subject to, or would comply with, any such 16
regulations, much less [Rules 15c3-1 and 15c3-3],” RCM could not 17

-- 28 of 38 --

29
be found liable under Section 10(b) and Rule 10b-5 for violating 1
Rules 15c3-1 and 15c3-3. RCM II, 586 F. Supp. 2d at 192. 2
Here, more than simply remaining silent as to whether it 3
was complying with U.S. law, RCM represented that it was not a 4
U.S.-regulated company. Although RCM did state that it was 5
subject to “all applicable laws” in the trade confirmations, 6
that simply raises the question of what laws were applicable. 7
In short, RCM’s alleged violation of federal law does not in and 8
of itself constitute deceptive conduct. 9
The Security and Exchange Commission has expressed a 10
concern, as amicus curiae, that affirming the district court in 11
this regard will viscerate the so-called “shingle theory” of 12
broker-dealer liability under Section 10(b), and will be 13
inconsistent with our recent decision in VanCook v. SEC, 653 14
F.3d 130 (2d Cir. 2011). We disagree. 15
Under the shingle theory, a broker makes certain implied 16
representations and assumes certain duties merely by “hanging 17
out its professional shingle.” Grandon v. Merrill Lynch & Co., 18
Inc., 147 F.3d 184, 192 (2d Cir. 1998). 19
In VanCook, we held that VanCook’s late-trading practice 20
“violated [Rule 10b-5] because it constituted an implied 21
representation to mutual funds that” VanCook was complying with 22
a rule restricting late-trading. VanCook, 653 F.3d at 141. We 23
reasoned that “by submitting orders after that time for 24
execution at the current day’s [Net Asset Value], VanCook made 25

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30
an implied representation that the orders had been received 1
before 4:00 p.m., because such late trading incorporates an 2
implicit misrepresentation by falsely making it appear that the 3
orders were received by the intermediary before 4:00 p.m. when 4
in fact they were received after that time.” Id. at 140-41 5
(internal quotation marks and alterations omitted). We also 6
noted that VanCook’s scheme violated his employer “mutual funds’ 7
own express wish’s, as set out in their propectuses,” id. at 8
140, and involved “steps to make it appear to any outside 9
observer . . . that his customers’ . . . orders had been 10
finalized by 4:00 p.m.,” id. Based in part on the explicit and 11
implied misrepresentations, we affirmed the order of the SEC 12
that VanCook violated Rule 10b-5 and Section 10(b). Id. at 141. 13
However, the facts alleged in the instant matter do not, as 14
asserted by appellant, give rise to liability based on “conduct 15
inconsistent with an implied representation; specifically a 16
broker-dealer’s implied representation under the ‘shingle 17
theory’ that it will deal fairly with the public in accordance 18
with the standards of the profession.” Appellants’ 18(j) Letter 19
at 2. Surely, RCM’s affirmative representations that it was not 20
a U.S.-regulated company trump any implied representation under 21
the shingle theory. 22
Indeed, we have previously denied shingle theory claims 23
against a broker that made adequate explicit disclosure with 24
regard to the subject matter of the claimed implied duties. See 25

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31
Starr ex rel. Estate of Sampson v. Georgeson S'holder, Inc., 412 1
F.3d 103, 111 (2d Cir. 2005) (denying plaintiffs' Rule 10b-5 2
claim under the shingle theory because defendant disclosed 3
allegedly excessive markups). In the instant case, RCM's 4
Customer Agreement and its standard form Trade Confirmation 5
expressly disclosed RCM's rehypothecation rights as well as 6
RCM's status as an offshore unregulated entity. These 7
disclosures were made in conjunction with a bargained-for 8
agreement between sophisticated counter-parties that could be 9
expected to understand the relevant benefits and risks. Thus, 10
there is no liability under the shingle theory. 11
The terms of the Customer Agreement indicated that, insofar 12
as RCM was acting as executing broker for its customers, RCM was 13
not purporting to comply with the Rules in question but was 14
relying on the safe harbor from broker registration provided 15
under SEC Rule 15a-6, 17 C.F.R. § 240.15a-6. In general, Rule 16
15a-6 exempts from the federal broker-dealer registration 17
requirements of Section 15(a) of the Exchange Act, 15 U.S.C. § 18
78o, “foreign entities engaged in certain activities involving 19
U.S. investors and securities markets.” See Registration 20
Requirements for Foreign Broker-Dealers, Exchange Act Release 21
No. 27,017, 54 Fed. Reg. 30013, 30013 (July 18, 1989). In 22
particular, Rule 15a-6(a)(3) exempts from registration foreign 23

-- 31 of 38 --

18 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
brokers 18 that induce or attempt to induce trades in securities 1
by “major U.S. institutional investors” and “U.S. institutional 2
investors” so long as any trades are “effected through” a U.S.- 3
registered broker-dealer and various conditions are met both by 4
the foreign broker and the registered dealer that effects the 5
trades. See 17 C.F.R. § 240.15a-6(a)(3)(i)(A). 6
Section G.1 of the Customer Agreement, entitled “Respective 7
Status of [RCM] and RSL,” provides in relevant part: 8
[RCM] and RSL are all wholly owned subsidiaries 9 of the Refco Group Ltd., LLC, a US corporation. 10 RSL is a US corporation and a broker-dealer 11 registered with the US Securities and Exchange 12 Commission. [RCM] is a Bermuda Corporation. 13
14 App. 156-57. 15
This language clearly indicates that RSL is a U.S. 16
corporation and registered with the SEC, thereby implying that 17
RSL would comply with SEC regulations. However, Section G.1 18
represents RCM only as a Bermuda Corporation and makes no 19
suggestion that RCM was registered with the SEC or would comply 20
with federal securities regulations. Furthermore, the Customer 21
Agreement’s frequent references to RSL as “introducing” 22

-- 32 of 38 --

19 Although RCM would have been exempt from registration under Rule 15a-
6, 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
transactions to RCM on the customers’ behalf clearly represented 1
that trades executed at RCM for its customers would be “effected 2
through” RSL to RCM in accordance with the requirements of Rule 3
15a-6(a)(3)(i)(A). 19
4
Accordingly, whether or not RCM was technically in 5
compliance with the Rule 15a-6(a)(3) safe harbor, 20 the Customer 6
Agreement clearly represented that RCM undertook no obligation 7
to comply with Rules 15c3-1 and 15c3-3. 8
Similarly, to the extent that RCM was acting as its 9
customers’ prime broker, RCM undertook no apparent obligation to 10
comply with federal securities laws, including Rules 15c3-1 and 11
15c3-3. Section G.1 of the Customer Agreement establishes the 12
role and function of RCM when acting as prime broker and states: 13
Trades Executed Away From [RCM], but cleared by 14 [RCM] (Prime Brokerage) –- [RCM] acts as your 15 clearing, settlement and financing agent (your 16 prime broker) in connection with Transactions 17 executed at your Executing Broker(s). Where 18 [RCM] is acting as your prime broker, no [RCM] 19 entity is involved in executing Transactions. 20
21
App. 157. 22

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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
The SEC has defined “prime broker” as “a registered broker- 1
dealer that clears and finances the customer trades executed by 2
one or more other registered broker-dealers (‘executing broker’) 3
at the behest of the customer.” Prime Broker Comm. Request, SEC 4
No-Action Letter, 1994 WL 808441, at *1 (Jan. 25, 1994). The 5
Commission requires prime brokers to comply with certain federal 6
securities laws, including Rules 15c3-1 and 15c3-3. Id. at *11. 7
However, insofar as RCM was not a U.S.-registered broker-dealer, 8
and thus not a “prime broker” for purposes of complying with 9
U.S. federal securities laws, RCM, when acting in its role as 10
prime broker, was not representing that it would comply with 11
Rules 15c3-1 and 15c3-3. 21 We therefore conclude that the 12
Customer Agreement represented that RCM intended to exercise 13
full rehypothecation rights without being subject to the Rules 14
in question. 15
RCM Customers also assert that RCM was subject to New York 16
General Business Law Section 339-e, which, in general, restricts 17
a broker’s rehypothecation rights with respect to fully-paid or 18
excess margin securities. N.Y. Gen. Bus. Law § 339-e (McKinney 19
2004). RCM Customers argue that Section 339-e applies because 20
Section H of the Customer Agreement and Paragraph 6 of the Trade 21

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35
Confirmation specified that the agreement would be governed by, 1
and construed in accordance with, New York law. In particular, 2
Section H of the Customer Agreement, entitled “LAW AND 3
JURISDICTION,” reads: 4
This Agreement shall be governed by and construed 5 with New York law and you agree that the courts 6 of New York, located in the Borough of Manhattan 7 (Federal or State), are to have jurisdiction to 8 settle any disputes which may arise out of or in 9 connection with this Agreement. Any suit, action 10 or proceedings arising out of or in connection 11 with this Agreement (“Proceedings”) commenced by 12 you, may only be brought in New York. [RCM] may 13 take proceedings against you in New York (Federal 14 or State) or any other court of competent 15 jurisdiction, US or otherwise. The taking of 16 Proceedings by [RCM] in one or more jurisdictions 17 does not preclude the taking of Proceedings by 18 [RCM] in any other jurisdiction, whether 19 concurrently or not. You irrevocably waive (and 20 irrevocably agree not to raise) any objection 21 which you may have now or subsequently to [RCM’s] 22 laying of the venue of any Proceedings in any 23 court and any claim that any such Proceedings 24 have been brought in an inconvenient forum. 25
26 App. 157. 27
The district court determined that Section H constituted a 28
choice of law provision that governed only the Customer 29
Agreement itself. RCM II, 586 F.Supp.2d at 192 n.27. However, 30
RCM Customers assert that Section H establishes that New York 31
law governed the overall relationship between RCM and RCM 32
Customers, including RCM’s use of RCM Customers’ collateral. We 33
agree with the district court. Section H neither created, nor 34
represented, any affirmative obligations on RCM to conform to 35

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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
New York margin-lending restrictions. 22 By its clear terms, the 1
provision was included only as a choice of law and venue 2
provision that would govern should any conflicts arise “out of 3
or in connection with” the Customer Agreement. 4
d) The Account Statements as a Misrepresentation 5
6 In addition to their deception-in-the-contract argument, 7
appellants also claim that the monthly account statements sent 8
by RCM were deceptive because those statements identified 9
security positions that were “In Your Account” and other 10
securities as “Open Financing Transactions,” indicating that the 11
latter were being held as collateral. They argue that these 12
statements implied that the securities held “In Your Account” 13
were not being rehypothecated but were being held on behalf of 14
the customer. 15
However, no such inference could reasonably have been drawn 16
by a signatory to the Customer Agreement, which gave RCM the 17
right to rehypothecate all securities, whether excess collateral 18
or not, as discussed supra. Based on the terms of the Customer 19
Agreement, the distinction between collateral securities and 20

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23 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
non-collateral securities had no bearing on rehypothecation 1
rights, but rather on what securities, or the equivalent cash 2
value thereof, customers could withdraw from their account. 3
Thus, these statements do not purport to make any 4
representation, deceptive or otherwise, about what securities 5
may or may not have been rehypothecated. 6
e) Oral Statements by RCM Representatives 7
8 RCM Customers also allege that oral statements made by RCM 9
representatives were deceptive. They state that during 10
discussions about the RCM Customers’ desire for low-risk 11
investments and a safe place to hold securities, RCM 12
representatives stated that: (i) RCM did not engage in 13
proprietary trading; (ii) their business involved only 14
executing, clearing, and financing trades in exchange for 15
commissions and interest payments; and (iii) RCM’s securities 16
financing business was a matched-book, which insulated RCM from 17
direct market risk. 23 Appellants argue that, in context, these 18
statements created the perception that RCM was “a dependable 19
custodian” for their securities and would not rehypothecate 20
excess margin securities. 21
However, none of these statements had any bearing on how 22
RCM intended to use excess margin securities. They state only 23
that RCM’s business was that of a broker-dealer and that it took 24

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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
steps to limit its risk. No reasonable, much less 1
sophisticated, investor would understand these statements as an 2
affirmative representation that RCM would not rehypothecate 3
excess margin securities. 4
Moreover, any doubt was removed by the terms of the 5
Customer Agreements, which granted RCM the right to 6
rehypothecate all customer securities whenever a customer had a 7
margin balance and the right to return customer securities in 8
the form of cash. These provisions clearly represented that 9
securities might be tied up in transactions even when not deemed 10
to be collateral. Therefore, the only affirmative statements by 11
RCM concerning the rehypothecation of customer securities were 12
the terms of the Customer Agreement, which were not deceptive. 24
13
CONCLUSION 14
We have also considered appellants’ remaining claims and 15
find them without merit. For the foregoing reasons, we affirm. 16
17
18

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