Mayer Brown in Crosshairs for Legal Work on Refco

Susan Beck

The American Lawyer

In June 26, 2007, Barry Colvert arrived at the midtown Manhattan office of Cooley Godward Kronish. Colvert is a former Federal Bureau of Investigation agent who has given polygraph tests to Israeli spy Jonathan Pollard, Soviet spy Aldrich Ames and former Los Alamos nuclear weapons scientist Wen Ho Lee.

On this day, Colvert, now a private consultant, would administer a test to a major law firm partner. Cooley had hired the former FBI agent in a desperate attempt to stave off an indictment of their client, Joseph Collins, a senior partner at Mayer Brown. The 58-year-old Collins was being targeted by federal prosecutors in the Southern District of New York for his role in the scandal at Refco Inc. The New York-based commodities trading firm collapsed in October 2005 after the discovery of massive internal fraud. Collins had been Refco's principal outside lawyer for more than 10 years, and prosecutors were building a case that the Mayer Brown partner was a party to the fraud.

Collins insisted that he was innocent. He said he didn't know that Refco's chief executive officer, Phillip Bennett, had hidden more than $1 billion in company losses by transferring them to an affiliated corporation and creating a secret intercompany debt. Collins didn't know that Refco executives hid that debt when they sold 57 percent of the commodities firm to buyout fund Thomas H. Lee Partners L.P. (THL) in 2004 for $507 million, he maintained.

The prosecutors didn't believe him. So the reserved and proper Collins allowed himself to be hooked up to a polygraph machine, according to court documents filed by Collins's lawyers.

"At the time of the sale of the Refco stock to Thomas Lee, were you aware that the intercompany debt was being concealed from [Thomas Lee]?" Colvert asked.

"No," Collins answered.

"At the time of the sale of Refco stock to Thomas Lee, had you been told there was over a billion dollars in intercompany debt?"

"No," Collins answered.

Colvert concluded that Collins was telling the truth. Using a "scoring algorithm" developed by Johns Hopkins University's Applied Physics Laboratory, Colvert stated in his written report that the probability of deception is less than 1 percent. Collins's lawyers, Cooley partners William Schwartz and Jonathan Bach, showed the results to prosecutors, but the government was unswayed.

On Dec. 18, 2007-more than two years after Refco went under -- Collins was indicted in federal court in Manhattan. He was the fifth person charged with Refco crimes, but the only one who wasn't a company insider. Collins is charged with 11 counts of securities fraud, bank fraud and related charges, and if found guilty he faces a sentence of up to 30 years. The government is also seeking forfeiture of a staggering $2.4 billion. His trial is scheduled for April.

In a decade that's seen waves of corporate scandals -- Enron, WorldCom, Tyco, Adelphia and Global Crossing -- Collins stands alone as the only outside lawyer to be indicted. Why him? It's important to stress that we don't know all the evidence against the Mayer Brown partner. Several Refco insiders are cooperating with prosecutors, and they could have damaging information. But on the basis of the allegations in the indictment, Collins faces a long term in prison for drafting documents for a company that turned out to be crooked and for allegedly making misrepresentations about things he may or may not have known to be false.

Collins hasn't been accused of devising or plotting Refco's fraudulent scheme, and unlike the four other Refco criminal defendants, it doesn't appear that he got rich from it. In hindsight, some of the things that Collins did for Refco look questionable but so do some of the things that Kirkland & Ellis and Vinson & Elkins did for Enron and its "special purpose entities."

Nearly all the people directly involved with Refco before it collapsed refuse to talk, in large part because the criminal prosecution is ongoing. The outlines of this story can be pieced together from the public record -- which includes court filings in the Refco criminal and civil cases -- an exhaustive investigation by Refco's bankruptcy examiner, and testimony in the recent trial of former Refco President Tone Grant.

For the lawyers involved, the outlines of the story aren't flattering. A kind reading of the facts suggests that at best they unknowingly enabled a vast fraud to be perpetrated. How did such a corrupt company operate for years under the eyes of not only Mayer Brown, but also Weil, Gotshal & Manges? (Weil was Refco's lead outside counsel in the year before it went public.) How did both firms miss the red flags? Why did neither firm ask the questions that would have at least contained this massive scandal?

Despite their joint connection to Refco, Mayer Brown and Weil, Gotshal stand at opposite ends of the stage in this drama. Not only has Weil pointed the finger at Collins, but it has sued Mayer Brown on behalf of buyout fund Thomas H. Lee. And, according to one lawyer familiar with the criminal prosecutions, Weil lawyers testified before the grand jury that indicted Collins and the other executives.

There's never a good time for a law firm partner to get indicted, but Collins' crisis comes at a particularly vulnerable time for Mayer Brown. More than 80 partners have left in the last two years, some because the firm slashed its equity partnership by 10 percent in 2007. Making matters worse, as it faces three Refco civil suits, the firm's malpractice coverage may be strained because of a $100 million settlement it paid in 2005 in an unrelated case, according to four former partners. In both cases, Mayer Brown's eat-what-you-kill culture arguably led to lapses in judgment that, in the end, hurt the clients and the firm.

Collins, who is on leave from Mayer Brown, and his lawyers declined to comment. Mayer Brown also declined to discuss this matter. Weil, Gotshal limited its comment to the following statement: "Weil, Gotshal & Manges LLP's representations of THL and Refco were totally appropriate and it performed its due diligence obligations in a thorough and highly professional manner."

Amidst all the questions, one thing seems clear. To a person, those who know Collins are stunned to see him accused of crimes. "He doesn't have that persona of somebody on the fast and loose," says one former partner who says he knows Collins well. "He was just the Richie Cunningham of Mayer Brown."

Collins may have had a squeaky-clean reputation, but his client was a mess of a company run by crooks. Refco CEO Bennett -- whose Cambridge University degree in geography isn't the usual pedigree of scoundrels -- pled guilty to fraud and other charges. In September, Bennett began serving a 16-year prison sentence; he's also been ordered to forfeit up to $2.4 billion in assets. Former Chief Financial Officer Robert Trosten and former Executive Vice President Santo Maggio have also pled guilty to fraud. They are cooperating with prosecutors and have not yet been sentenced.

Refco's subterfuge was laid bare earlier this year during the Grant trial. Grant, who is a lawyer, was president of Refco before Bennett took over in 1998; after he left, he continued as a major shareholder. Grant did not testify in his defense but his lawyers at Zuckerman Spaeder maintained, as Collins does, that their client wasn't aware of the fraud. Like Collins, Grant claimed that he had been duped by Bennett, who was, in the words of partner Roger Zuckerman, "an unrestrained pathological liar." Still, in a development that must terrify Collins, Grant was found guilty in April of conspiracy, securities fraud, wire fraud, bank fraud and money laundering, and was sentenced to ten years. He has appealed.

Bennett and his cohorts were good at lying, but they weren't good at running a company. Refco suffered huge losses, often because it loaned millions of dollars to clients who invested on margin and then couldn't cover their losses. Sometimes it made bad investments of its own. Starting at least in 1997, Bennett, aided by Maggio and others, crafted a plan to hide Refco's losses from auditors and regulators by moving them off the books. The concept was similar to what Enron had done: hide losses with off-balance-sheet vehicles.

This wasn't the first time that Refco had skirted the law. The brokerage firm had a rogue history, stretching back to its founding in 1969 by Ray Friedman. He had spent 23 months in prison for selling substandard chickens to the U.S. Army during the Korean War. (Refco is an acronym for Ray E. Friedman & Co.) Since 1983, when Bennett became chief financial officer, regulators cited Refco more than 140 times for a host of transgressions, including siphoning money from clients' accounts. In 1999 the company tried to improve its image by hiring Dennis Klejna from Vinson & Elkins as its general counsel. Klejna had been chief of enforcement at the Commodity Futures Trading Commission from 1983 to 1995.

Collins seemed nothing like the devious Refco executives. The head of Mayer Brown's derivatives group, he was known as a quiet and reserved family man, with a wife, children, grandchildren and a nice home in the affluent Chicago suburb of Winnetka. "There was no question about his honesty or integrity," says former Mayer Brown partner Joseph Doyle, who is now general counsel of Pactiv Corporation. Former partner Dennis Orr likewise finds it hard to believe Collins would knowingly be involved in fraud. "I would say he is morally scrupulous," says Orr, now a partner at Morrison & Foerster. "I never would have associated him with anything immoral." Collins, a New York University School of Law graduate, joined Mayer Brown in 1994 from Schiff Hardin & Waite, bringing Refco with him. He was considered one of the top lawyers in the field of commodities regulation. Despite his professional stature, few Mayer Brown partners knew much about Refco or Collins' practice. Several former partners note that Mayer Brown is a firm where partners often function as separate islands, largely because the firm's eat-what-you-kill compensation system heavily rewarded partners for the business they control. "The culture at Mayer Brown was to hoard work and not open your clients to other people," says one former partner, in a comment echoed by several others. "If partners tell you they had no clue what Collins was doing, that's the culture there."

Refco, which was the largest broker on the Chicago Mercantile Exchange, generated healthy billings for Collins, and he spent about half his time on the company. According to the indictment, from 1997 to 2005 Mayer Brown billed $40 million to Refco, which works out to $4.4 million a year. Collins handled mostly regulatory matters; the firm also did employment and litigation work for the brokerage. Collins was well paid, but not a superstar, earning $1.6 million to $2 million annually in recent years, according to a former partner.

One recurring assignment that Collins started handling for Refco in 2000 was documenting large, short-term loans that some of its corporate affiliates entered into at the end of each fiscal year. How much Collins knew about these loans goes to the heart of his case. As it turns out, Bennett was using these "round-trip" loans to hide Refco's massive mounting losses. Collins claims he had no idea.

Most of the drafting was done by associates and counsel at the firm, supervised by Collins. Apart from him, five Mayer Brown lawyers have been identified as having a role in these deals; all either declined to comment, did not return calls, or could not be located.

In court papers, Collins and Mayer Brown stress that they didn't know they were abetting a fraud because they were kept in the dark about the step in the transaction that wiped out the debt that Refco was trying to hide. Only this step -- the transfer of money from Refco Group Holdings Inc. to Refco -- created the fraud, they maintain. Mayer Brown also argues that there's nothing inherently wrong with round-trip loans, stating in court papers that they're commonly used in financings and for tax purposes. In fact, the firm noted, JPMorgan Chase used such loans when it acquired the assets of The Bear Stearns Companies Inc. earlier this year.

But one former Mayer Brown lawyer argues that a short-term, round-trip loan should have prompted Collins to ask questions. "It's hard for me to understand how anyone could work on loan documents and not ask, 'What is the purpose behind this loan?'" he says. "When you're doing a financing, knowing the use of proceeds is important to understand whether the loan is illegal."

What about general counsel Klejna, the former CFTC director of enforcement? Did he know that Mayer Brown was drafting the loan documents? None of this is clear. (Klejna did not testify at Grant's trial, and there was little testimony about the GC's role.) Klejna has had a softer landing than Collins, although he agreed to pay $7.6 million to settle a shareholder suit. He has not been charged with any crimes, and last year he was hired as senior vice president and chief compliance counsel of Man Financial Inc., a futures brokerage firm. Reached at his new job, Klejna declined to comment. It's not clear if the government plans to call him as a witness against Collins.

By 2004 Bennett wanted to cash out of Refco. He couldn't find a buyer for the whole company, so he settled for a partial buyout by Thomas H. Lee Partners. The LBO firm is one of the country's oldest and most sophisticated, with a track record of profitable investments that includes Dunkin' Donuts, Houghton Mifflin Company, and Snapple Beverage. According to testimony in the Grant trial, THL did $10 million worth of due diligence on Refco before it went forward. (Those fees were, however, paid by Refco.) The fund was represented by its regular outside counsel, Weil, Gotshal, led by Boston partner James Westra, a private equity and hedge fund specialist who sits on Weil's management committee.

Collins was Refco's lead lawyer for the buyout, and one former Mayer Brown senior associate who worked on the deal says Collins may have been in over his head. "Joe is a derivatives lawyer, not a true M&A lawyer," says Shant Chalian, who is now a partner at Hodgson Russ. This was an "immensely complex transaction," Chalian says, and it should have been done by a seasoned corporate lawyer. But, he notes, Mayer Brown's compensation system didn't reward partners for passing work along or for helping others. Chalian wonders if Collins' mild-mannered demeanor might have caused problems for him, too: "I don't think I ever heard him raise his voice. I think that might have been his undoing. Someone with an edgier personality might have gotten more help on the deal."

When the LBO closed in August 2004, with THL paying more than half a billion dollars for 57 percent of Refco, Weil took over as Refco's lead counsel. Despite the potential for conflict, Weil continued to represent majority shareholder THL. The buyout firm's goal was to get Refco ready for an IPO the following year, giving THL a quick exit and a fast profit. The interests of Weil's other client, Refco (and its future public shareholders), weren't necessarily helped by a fast-tracked IPO. As it turned out, the bankruptcy examiner would later find that, in the rush to get Refco to market, Weil's due diligence was slipshod, and the firm overlooked red flags that might have revealed Refco's fraud.

After the LBO, Bennett brazenly continued to hide losses with the round-trip loans, and Mayer Brown continued to document parts of the transactions. It's not clear how, in the year between the LBO and the IPO, THL missed this fraud going on under its nose, especially since it had installed its own people as president, treasurer and secretary. (Klejna continued as general counsel.) Refco's bankruptcy trustee, Marc Kirschner, alleges that THL-which took $275 million out of Refco before it went under -- knew that something was badly amiss, but was hell-bent on cashing out in the IPO. In a complaint against the buyout fund, the trustee's lawyers at Milbank, Tweed, Hadley & McCloy wrote that before the IPO, "[Thomas Lee] learned that Refco's financial function was in shambles, that its internal accounting and external auditing functions were ineffective, and that Refco was in no condition to be a public company." In its answer, THL denied any knowledge of Bennett's fraudulent scheme.

On Aug. 11, 2005, Bennett stood on the floor of the New York Stock Exchange and rang the opening bell as Refco went public. The stock rose 25 percent that day. But the house of cards soon toppled. Within weeks Refco's new controller discovered the fraud, and on Oct. 10, 2005, Refco announced that its financial statements could no longer be relied on.

Bennett was arrested the next day. He was caught making damaging statements in a recorded phone call with Refco executive Maggio, who had rushed to prosecutors to strike a deal. Less than a week later, Refco and 23 of its unregulated affiliates filed for Chapter 11 bankruptcy.

Collins said that he was "dumbfounded" when he learned the news about the financial statements, according to his court filings.

Understandably, Mayer Brown partners were worried about their exposure. The firm had just paid a huge settlement because of another client caught in a fraud, Commercial Financial Services Inc. Several former Mayer Brown partners say the firm paid roughly $100 million in 2005, and not all was covered by insurance. At the firm's annual partners meeting in April 2006, Mayer Brown's then general counsel, James Holzhauer, told partners that if the firm was hit with another big claim, it risked being thrown out of the lawyer-owned mutual insurance company Attorneys' Liability Assurance Society, according to three former partners. At the same time, Holzhauer and others in management tried to reassure partners about Refco. Recalls one: "They kept saying, don't worry about Refco. It's not like CSF." (Holzhauer became chairman in June 2007.)

But trouble was brewing. The bankruptcy court had appointed Joshua Hochberg as examiner to explore possible claims against Refco's outside professionals, and he brought a prosecutor's zeal to his task. The Washington, D.C., partner at McKenna Long & Aldridge had been chief of the fraud section at the U.S. Department of Justice and had supervised the Enron task force. For Refco, he amassed more than a million documents and interviewed 33 people. (So as not to interfere with the criminal investigation, he did not interview any Refco insiders.)

In the spring of 2007, Collins met with Hochberg, accompanied by Cooley's Schwartz and Williams & Connolly's John Villa, representing Mayer Brown. Collins denied knowing that Refco used the round-trip loans to conceal fraud, according to Hochberg's report. Collins said that he didn't know at the time why the loans were being done, and that he didn't ask. He didn't believe that it was his job to find out, he told Hochberg. Collins admitted that he knew there was a receivable from affiliate RGHI to Refco, but says he didn't know how big it was.

Hochberg also interviewed the five other current and former Mayer Brown lawyers who worked on these loans. Like Collins, they all denied knowledge of a fraud.

Hochberg didn't like the answers he received. In his written report, released July 11, 2007, he didn't explicitly say that he thought Collins and the others were lying, but he came close. Even though they all denied any knowledge of Refco's fraud, and even though Hochberg could not find any "direct evidence" in more than 1 million pages of documents that Mayer Brown knew about the fraud, he still concluded that they must have known. "Circumstantial evidence, taken as a whole, is sufficient to support the conclusion that Mayer Brown had such knowledge," Hochberg wrote.

The examiner may have assumed the worst about the Mayer Brown lawyers because he thought they were evasive. He pointedly noted that Collins and the five other lawyers he interviewed "had little or no recollection of the specific events" they were asked about, and, "in virtually every case," their recollections weren't refreshed by documents. (The Mayer Brown lawyers were, in fairness to them, asked about more than 17 transactions stretching back to 2000.) Hochberg also noted that Mayer Brown objected to the presence of a court reporter to transcribe the interviews.

One former Mayer Brown partner wonders if Williams & Connolly's Villa, who is a tough advocate for law firms, might have erred by not encouraging more cooperation. "[Villa's] approach is to not give a lot of information," says one former Mayer Brown partner. Says another: "Joe [Collins] and the firm so badly handled the bankruptcy examiner's investigation [that] they gave the impression they were not being truthful." Villa, who notes that each of these lawyers was represented by individual counsel, says that he "respectfully disagrees" with the suggestion that the witnesses were uncooperative or not forthcoming.

When Hochberg interviewed the Weil lawyers, their recollections were much better. Part of what they remembered was that Collins had misled them. Weil partner R. Jay Tabor, who oversaw the due diligence, stressed that Collins told him before the LBO that Refco didn't have any undisclosed intercompany debt, which proved to be false. Tabor also blamed Collins for not disclosing that several senior Refco executives had a "profits interest" in the company, when Weil asked for information about executives' equity interests. (It's not clear why he didn't disclose this. It's possible he considered profits interests to be different from equity interests.)

Hochberg's investigation had repercussions beyond the bankruptcy proceedings. He was sharing information with federal prosecutors. Soon after Collins' spring interview with Hochberg, the Mayer Brown partner got the first indication in May 2007 that he was a target of the government's investigation, according to his court filings. Within weeks of discovering that he could be a criminal defendant, Collins took the lie detector test.

During the remainder of 2007, the bad news for Collins and Mayer Brown snowballed. Hochberg's report was released that July and came down hard on Collins and Mayer Brown, stating that the firm could be sued for malpractice, aiding and abetting the breach of fiduciary duty, and, most alarmingly, aiding and abetting fraud. In late July 2007, on the heels of this report, Weil sued Mayer Brown for RICO fraud and other claims, seeking more than $735 million for THL. The next month, Refco's trustee Kirschner sued Mayer Brown, seeking $2 billion. The following October, Mayer Brown was added as a defendant to the Refco shareholders' complaint.

Mayer Brown wasn't the only one targeted for civil liability. Bankruptcy trustee Kirschner also sued THL, Refco's auditors, the underwriters for the IPO, and even some of the parties who had done round-trip loans with Refco. In fact, the only one connected to Refco who didn't get sued was Weil. The firm may have escaped a lawsuit because of a friendly relationship with the trustee's lawyers at Quinn Emanuel Urquhart Oliver and Hedges, who didn't feel comfortable suing a firm that refers work to them. "We advised the trustee early on that, based on our working relationship with Weil, Quinn Emanuel would not undertake to investigate or bring claims against Weil," says one partner at Quinn. Kirschner hired another law firm, Milbank, Tweed, to bring claims against THL, and it's not clear if Milbank reviewed possible claims against Weil. Kirschner and Milbank declined to discuss the matter.

On the morning of Dec. 18, 2007, Mayer Brown partners were summoned to a meeting. Speaking from New York, Chairman Holzhauer informed the lawyers that Collins had been indicted. "It was short and to the point," said one lawyer. "He said Joe and the firm had engaged in no wrongdoing." The partner adds, "It shook me. I was not expecting this news." Attorneys who gathered in New York openly asked if this might lead to an Arthur Andersen-type crisis that could bring down the firm.

Why did it take prosecutors two years after Refco's fall to indict Collins? The answer might lie in the events of the following day. On Dec. 19 the government announced that it had reached a plea deal with former Executive Vice President Maggio, who had rushed to prosecutors to turn in Bennett. It's likely that Maggio's deal requires him to testify against Collins. Maggio, however, doesn't have the most impeccable reputation. In the Grant trial, he admitted to money laundering and paying bribes at another company, and to playing a major role in concealing Refco's losses. He also admitted to having committed perjury repeatedly in Refco civil litigation.

In announcing the indictment, the government stressed that this case was more than a matter of guilt by association. In a prepared statement, Manhattan U.S. Attorney Michael Garcia stated that Collins "was not merely a lawyer whose client was committing fraud and who should have caught on -- Collins instead played an active and crucial part in perpetrating the Refco fraud." The 55-page indictment goes beyond Collins's role in the round-trip loans. He is also charged with hiding information from the Weil lawyers, including details of the executives' profits participation. Weil lawyers may appear as witnesses against Collins. The government has asked for an embargo on any depositions of Weil lawyers in the civil litigation, so as to preserve their testimony for the criminal case, according to one lawyer involved in the litigation. Collins, who also faces a civil suit from the Securities and Exchange Commission, may be more culpable than others who represented corrupt clients in recent years, or he may simply be the victim of terrible luck. "Kirkland had numerous people working on things [for Enron entities]," says one former Enron prosecutor, contrasting that firm to Mayer Brown and Collins, who worked on Refco matters in relative isolation. "If you have 10 people in a law firm involved, it's not the same as one person involved in the totality. It's harder to show criminal intent." He adds, "There's safety in numbers. That's the reality."

Collins doesn't come into his office at Mayer Brown anymore these days. According to people who know him, he's spending most of his time on his defense. In August, Collins' lawyers filed a motion to have the results of the lie detector test admitted as evidence at his trial, which Manhattan federal district court Judge Leonard Sand denied. "I would be shocked if Collins pled guilty," says a lawyer for a former Refco executive. "I think his lawyers really believe he's innocent." Even if he is exonerated, his career and life will never be the same.