Where Were the Lawyers? One is Found

“Where were the outside accountants and lawyers when these transactions were effectuated?”

This is a now famous refrain made by former SEC Director of Enforcement and U.S. District Court Judge Stanley Sporkin in his opinion in Lincoln Savings & Loan Ass’n v. Wall, 743 F. Supp. 901, 920 (D.D.C. 1990), as well as during his term as Enforcement Director. For investors and for Refco, a defunct New York financial services firm, at least one lawyer was discovered far too late. Today, the U.S. Attorney’s Office for the Southern District of New announced an eleven count indictment naming attorney Joseph Collins, former head of Mayer Brown’s derivative practice, as a defendant, alleging he was a key player in the financial demise of Refco. U.S. v. Collins, Case No. 1:07-cr-01170-LBS, (S.D.N.Y. Filed Dec. 18, 2007); SEC v. Collins, Case No. 07 CV 11343 (S.D.N.Y. Filed Dec. 18, 2007).

The indictment naming Mr. Collins is the latest in a series of actions arising out of the demise of once high-flying Refco. At one time, Refco was a major provider of execution and clearing services for exchange-traded derivatives and prime brokerage services in the fixed income and foreign exchange markets. In August 2004, approximately 53% of the firm was acquired by a group headed by Thomas H. Lee Partners, L.P. in a $1.9 billion leveraged buyout. The next year, the firm conducted an initial public offering of its shares, raising about $583 million from the public. Within weeks of the IPO, the true financial condition of Refco began to emerge and the company collapsed in bankruptcy.

Previously, Phillip Bennett (Refco’s former CEO), Robert Torsten (the former CFO) and Tone Grant (an owner and president) were indicted on charges stemming from the debacle. Those cases are scheduled for trial on March 17, 2008. In addition, Thomas H. Lee Partners has filed a civil suit. Thomas H. Lee Equity Fund v. Mayer Brown, Civil Action No. 07 CIV 6767 (S.D.N.Y. Filed July 2, 2007); see also Krischner v. Grant Thorton, Civil Action No. 07CV 5306 (N.D. Ill Filed Sept. 19, 2007).

The charges filed against Mr. Collins today are based on his role as longtime outside counsel for Refco. According to the indictment, Mr. Collins was a key participant in a massive financial fraud which concealed the true financial condition of Refco from its investors, lenders and the public. The charges allege, for example, that Mr. Collins facilitated “round trip” lending transactions, in which a company controlled by Mr. Bennett would loan funds to Refco over the end of a period and then borrow them back after the closing to conceal huge debts of Refco. At other times, according to the charge, Mr. Collins would edit deal documents to conceal references to Refco’s massive debts from investors and others. Specifically, the indictment charges that Mr. Collins:

• assisted Mr. Bennet in concealing Refco’s debt, which had ballooned to over $1 billion dollars with the “round trip” lending transactions;

• falsely represented to Thomas H. Lee Partners and others that all material contracts and related party transactions had been disclosed when in fact he knew that the “round trip” transactions had been concealed;

• made affirmative misrepresentations and prepared contracts in such a manner as to mislead others into believing that CEO Bennett’s holding company that was involved in the round trip loan transactions only owed about $108 million, rather that at least $ 1 billion;

• misled Thomas H. Lee Partners and its representatives into believing that Refco had about $500 million in excess working capital when it did not; and

• assisted in the preparation of a registration statement filed with the SEC for Refco’s IPO which falsely concealed related party transactions, the round trip loan transactions and thus the true financial condition of the company.

Overall, the indictment claims that Mr. Collins acted “hand-in-hand with Bennett … [making] affirmative misrepresentations, material omissions, and … [telling] deceptive half-truths, all to assist Bennett’s scheme to seal more than $2.4 billion from potential investors and lenders.”

The indictment contains eleven counts, including one count of conspiracy to commit securities fraud, wire fraud, bank fraud and money laundering and making false statements to auditors, two counts of securities fraud, two counts of making false filings with the SEC, a count of wire fraud and a count of bank fraud.

The SEC’s complaint is similar to the indictment. It is also keys to the critical role Mr. Collins played as the long time outside lawyer to Refco and his excellent reputation and that of his firm which he used to further the scheme. The factual allegations focus on claims related to the filing of the IPO. The compliant contains a single count of fraud in violation of Exchange Act Section 10(b)and seeks an injunction and monetary penalty for relief.

Collins gives new meaning to the comments of Judge Sporkin by again highlighting the critical role attorneys perform and the meaning of their position as “gatekeepers.” At the same time, it reemphasizes the important obligations of counsel. The case also serves to highlight the issues in Stoneridge (discussed here) which is under consideration by the Supreme Court. There, the Court is considering the scope of Section 10(b), scheme liability, and who can be named as a primary violator. That issue of course does not exist for the SEC, which can bring cases for aiding and abetting following the amendments to the Exchange Act in the PSLRA. Despite the key role that the U.S. attorney’s office and the SEC claim Mr. Collins played in the Refco scandal, the SEC’s complaint only charges aiding and abetting.