## Facts

- Investment funds maintained brokerage accounts with Refco Capital Markets, Ltd. (RCM), an offshore broker affiliated with Refco Inc.
- Customer agreements permitted customers to post securities as collateral for margin loans and authorized RCM to rehypothecate customer securities for RCM’s financing purposes.
- The agreements disclosed that RCM was an offshore, unregulated entity.
- Upon provision of margin financing, customers granted RCM a perfected security interest in customer cash, securities, and other property in RCM’s possession or control; RCM’s obligation was limited to returning property (or its cash value) not deemed collateral.
- After Refco and RCM entered bankruptcy, customers alleged that Refco-related officers/directors and the auditor committed securities fraud by failing to disclose that customer securities would be rehypothecated and used for Refco’s benefit, including to mask losses.
- Customers asserted they believed their securities would be handled consistent with ordinary U.S. brokerage practices and law, and that defendants’ conduct was deceptive under federal securities laws.
- The SEC, as amicus, argued that affirming dismissal could weaken broker-dealer liability associated with the “shingle theory.”

## Issues

1. Whether the complaint adequately alleged a material misrepresentation, omission, or deceptive act under federal securities laws based on RCM’s rehypothecation and use of customer securities.
2. Whether explicit customer-agreement terms authorizing rehypothecation and disclosing RCM’s offshore, unregulated status defeated claims that customers were misled (including under a “shingle theory” theory of deception).
3. Whether plaintiffs plausibly alleged that, at the time of contracting, RCM lacked a present intent to perform the customer agreements (so that alleged nonperformance could constitute actionable securities fraud rather than a contract dispute).

## Decision

- The Second Circuit affirmed dismissal of the securities-fraud claims.
- The court assumed, without deciding, that plaintiffs had standing, but held the pleadings did not state actionable deception.
- The agreement’s express provisions authorized the challenged rehypothecation and granted RCM broad rights in customer collateral, undermining any claim that the contract misrepresented RCM’s practices.
- The complaint failed to plausibly allege that RCM entered the agreements with a then-present intent not to comply, which was necessary to convert alleged nonperformance into fraud.
- The court rejected the argument that enforcing clear contractual disclosures would abolish the “shingle theory,” distinguishing between undisclosed misconduct and conduct expressly disclosed in the customer agreement.

## Legal Principles

- A securities-fraud claim requires well-pleaded allegations of a material misstatement/omission or other deceptive conduct; contractual nonperformance alone does not suffice.
- Where an agreement explicitly authorizes the challenged conduct and contains clear disclosures about the broker’s status and rights, plaintiffs must identify a specific false statement or materially misleading omission to plead deception.
- Allegations that a defendant breached a contract support securities fraud only if coupled with plausible facts showing a present intent not to perform at the time the agreement was made.
- Broker-dealer “shingle theory” concepts do not override explicit, clear disclosures that inform customers of practices the broker is contractually permitted to undertake.

## Conclusion

The Second Circuit held that customers could not obtain securities-law relief for losses tied to RCM’s use of customer collateral where the governing agreements disclosed rehypothecation rights and the broker’s offshore, unregulated status, and the complaint failed to plead a material misrepresentation or a present intent not to perform at the time of contracting.


Capital Mgmt. Select Fund Ltd. v. Bennett, 680 F.3d 214 (2d Cir. 2012)